econ 308 ch 22

an autonomous increase in net exports at any given inflation rate adds directly to aggregate demand and so

raises aggregate demand *AD shifts right*

the long-run aggregate supply curve shifts to the right when there is

(1) an increase in the total amount of capital in the economy, (2) an increase in the total amount of labor supplied in the economy, (3) an increase in available technology, or (4) a decline in the natural rate of unemployment

what demand shocks shift the AD curve?

(1) autonomous monetary policy, (2) government purchases, (3) taxes, (4) autonomous net exports, (5) autonomous consumption expenditure, (6) autonomous investment, and (7) financial frictions

the short-run aggregate supply curve is based on the idea that three factors drive inflation:

(1) expectations of inflation, (2) the output gap, and (3) inflation (supply) shocks

when the Federal Reserve decides to increase this autonomous component of the real interest rate, the higher real interest rate at any given inflation rate leads to a higher cost of financing investment projects, which leads to

a decline in investment spending and the quantity of aggregate demand (*AD curve shifts left*)

what is the self-correcting mechanism?

a characteristic of the economy to return eventually to the natural rate level, regardless of where it lies initially

a permanent negative supply shock initially leads to

a decline in output and a rise in inflation. In the long run, it leads to a permanent decline in output and a permanent rise in inflation

examples of temporary negative supply shocks include

a disruption in oil supplies, a rise in import prices when a currency declines in value, or a cost-push shock from workers pushing for higher wages that outpace productivity growth, driving up costs and inflation

temporary positive supply shocks include

a particularly good harvest or a fall in import prices

what is the difference between aggregate supply and aggregate demand?

aggregate demand is the total amount of output demanded at different inflation rates aggregate supply is the total amount of output that firms in an economy want to sell at different inflation rates

an increase in government purchases at any given inflation rate adds directly to aggregate demand expenditure, and hence

aggregate demand rises *AD shifts right*

the amount of output that can be produced in the economy in the long run is determined by?

amount of capital in the economy, the amount of labor supplied at full employment, and the available technology. *increase in any of these shifts LRAS to the right because potential output rises*

what is a supply shock?

any change in technology or the supply of raw materials that can shift the AS curve

when aggregate output falls below potential output, the short-run aggregate supply curve shifts

down and to the right. only when aggregate output returns to potential output does the short-run aggregate supply curve stop shifting

a permanent positive supply shock

lowers inflation and raises output in both the short run and the long run

at any given inflation rate, an increase in taxes lowers disposable income, which leads to lower consumption expenditure and aggregate demand, so that aggregate demand ...

falls *AD shifts left*

when financial frictions increase, the real cost of borrowing increases, so planned investment spending falls at any given inflation rate, and aggregate demand

falls *AD shifts left*

(definition) the point at which all markets are simultaneously in equilibrium and the quantity of aggregate output demanded equals the quantity of aggregate output supplied

general equilibrium

more flexible wages and prices imply that the value of γ is higher, which in turn implies that the short-run aggregate supply curve

is steeper if wages and prices are completely flexible, then γ becomes so large that the short-run aggregate supply curve becomes vertical and is identical to the long-run aggregate supply curve

a temporary negative supply shock leads to an upward and leftward shift of the short-run aggregate supply curve, which initially raises inflation and lowers output, the ultimate long-run effect is that

output and inflation are unchanged

what are cost-push shocks?

price shocks that occur when workers push for wages that are higher than productivity gains, thereby driving up costs and inflation

why is there a SRAS and LRAS curve?

prices and wages take time to adjust to their long run levels

what is the relationship of the aggregate supply curve?

quantity of output supplied and the price level

when the inflation rate rises, how do monetary authorities react?

react by raising the real interest rate to keep inflation from spiraling out of control

if the natural rate of unemployment declines, it means that labor is being more heavily utilized, and so potential output will increase. a decline in the natural rate of unemployment thus shifts the long-run aggregate supply curve to the

right

when businesses become more optimistic, autonomous investment rises and businesses spend more at any given inflation rate. Planned investment increases and aggregate demand

rises *AD shifts right*

when consumers become more optimistic, autonomous consumption expenditure rises, and so consumers spend more at any given inflation rate. aggregate demand therefore

rises *AD shifts right*

unfavorable supply shocks that drive up inflation cause the short-run aggregate supply curve to

shift up and to the left

a rise in expected inflation causes the short-run aggregate supply curve to

shift upward and to the left

a rise in expected inflation (positive inflation shock)...

shifts SRAS upward

what relationship does the AD curve show?

shows the relationship between the price level and quantity of aggregate output demanded when the goods and money market are in equilibrium

when the real interest rate is higher...

the cost of financing purchases of new physical capital becomes higher, making investment less profitable and causing planned investment spending to decline

what is the level of output produced at the natural rate of unemployment called?

the natural rate of output or potential output

what is the output gap?

the percentage difference between aggregate output and potential output, Y - YP

what is the natural rate of unemployment?

the rate of unemployment consistent with full employment; the rate at which the demand for labor equals the supply of labor. many economists believe it to be between 4% and 5%

if Y = YP if Y < YP if Y > YP

u/e = natural rate of unemployment recessionary gap, u/e above natural rate inflationary gap, u/e below natural rate

when output exceeds its potential level and the output gap is positive, there is

very little slack in the economy. workers will demand higher wages, and firms will take the opportunity to raise prices. the end result will be higher inflation

why is the AD curve sloped downwards?

when inflation rate rises, authorities raise real interest rates in response to keep inflation from spiraling out of control. this results in a decrease in planned investment spending, causing aggregate demand to fall. *a higher inflation rate therefore leads to a lower level of quantity of aggregate output demanded*