Macroeconomics Exam: Chapter 13
3 variables that shift the aggregate demand curve
1. changes in monetary policy and fiscal policy 2. changes in the expectations of households and firms 3. changes in foreign variables
3 potential explanations for why the SRAS's is upward sloping
1. contracts make some wages and prices sticky 2. firms are often slow to adjust wages 3. menu costs make some prices sticky
5 most important variables that cause the short run curve to shift
1. increases in the labor force and in the capital stock 2. technological change 3. changes in expected future price level 4. adjustments of workers and firms to errors in past expectations about the price level 5. unexpected changes in the price of an important natural resource
basic aggregate demand and aggregate supply models provide misleading results sometimes, however it assumes that
1. price levels were constant (no inflation) 2. there was no long run growth
2 assumptions abut recessions, expansions and supply shocks
1. the economy hasn't been experiencing any inflation. the price level is currently 115, and workers and firms expect it to remain at 115 in the future 2. the economy isn't experiencing any long run growth, potential gdp is $20.0 trillion and will remain at that level in the future
stagflation
A combination of inflation and recession, usually resulting from a supply shock.
According to the dynamic AD-AS model, what is the most common cause of inflation?
AD increases by more than LRAS. Total spending increases faster than total production.
Suppose that initially, the economy is in long-run macroeconomic equilibrium at point A. If there is increased pessimism about the future of the economy, the AD curve will shift from ____
AD0 to AD1
Refer to the figure to the right. Ceteris paribus, an increase in households' expectations of their future income would be represented by a movement from
AD1 to AD2.
Refer to the figure to the right. Ceteris paribus, an increase in interest rates would be represented by a movement from
AD2 to AD1.
Interest rates in the economy have fallen. How will this affect aggregate demand and equilibrium in the short run?
Aggregate demand will rise, the equilibrium price level will rise, and the equilibrium level of GDP will rise.
supply shock
An unexpected event that causes the short-run aggregate supply curve to shift often caused by unexpected increases/ decreases in the prices of important natural resources that cause costs to be different than expected
financial crisis
As many people defaulted on their mortgages, many financial institutions took heavy losses. This financial crisis led to a credit crunch, decreasing consumption and investment spending
How does an increase in the price level affect the quantity of real GDP supplied in the long run?
Changes in the price level do not affect the level of GDP in the long run.
Consider the figure to the right. Why does the short-run aggregate supply curve (SRAS) slope upward?
Contracts keep wages "sticky". Prices of final goods rise more quickly than the prices of inputs. Firms and workers fail to predict changes in the price level.
Which of the following is one explanation as to why the aggregate demand curve slopes downward? A. Decreases in the price level raise the interest rate and increase consumption spending. B. Decreases in the price level raise the interest rate and increase investment spending. C. Decreases in the U.S. price level relative to the price level in other countries lower net exports. D. Decreases in the price level raise real wealth and increase consumption spending.
Decreases in the price level raise real wealth and increase consumption spending.
The end of the housing bubble
House prices rose in the early 2000s—initially due to low interest rates, but then due to speculation. In 2006, the speculative bubble began to deflate, and the spending on residential investment fell.
Changes in Foreign Variables
If firms and households in other countries buy fewer U.S. goods or if firms and households in the United States buy more foreign goods, net exports will fall, and the aggregate demand curve will shift to the left.
Indicate which of the following would cause a shift in the aggregate demand curve from point A to point C. (Mark all that apply.) A. Lower interest rates B. Decrease in the price level C. Inflation D. Decrease in the U.S. exchange rate relative to other currencies E. Increased consumer optimism F. Lower taxes
Lower interest rates Decrease in the U.S. exchange rate relative to other currencies Increased consumer optimism Lower taxes
contracts make some wages and prices sticky
Prices and wages are said to be "sticky" when they do not respond quickly to changes in demand or supply. Some firms and workers fail to predict price level changes, and hence do not correctly build them into long-term contracts. SRAS - upward sloping
Long-run adjustment will shift the SRAS curve from _____ as workers adjust to lower-than-expected prices.
SRAS 0 to SRAS 1
Refer to the figure to the right. Ceteris paribus, an increase in productivity would be represented by a movement from
SRAS1 to SRAS2.
Refer to the figure to the right. Ceteris paribus, an increase in the expected future price level would be represented by a change from
SRAS2 to SRAS1.
rapid increase in oil prices during 2008
Several factors combined to increase the price of oil from $34 per barrel in 2004 to $140 per barrel in mid-2008. This supply shock exacerbated the ongoing recession.
4 major alternative models
The Monetarist Model The New Classical Model The real business cycle the Austrian model
How do lower taxes affect aggregate demand?
They increase disposable income, consumption, and aggregate demand.
Consider the downward-sloping aggregate demand (AD) curve to the right. Which of the following results in a movement from point A to point B (a movement up along the AD curve) or from point A to point C (a movement down along the AD curve)? (Mark all that apply.) A. Inflation effect B. Multiplier effect C. Wealth effect D. Interest rate effect
Wealth effect Interest rate effect
the interest rate effect
When the price level increases, lenders need to charge higher interest rates to get a REAL return on their loans. Higher interest rates discourage consumer spending and business investment.
An increase in the value of which of the following would not increase household wealth? A. a credit card balance B. the equity in one's home C. 500 shares of Google stock D. the balance in your savings account
a credit card balance
aggregate demand curve (downward sloping)
a curve that shows the relationship between the price level and the quantity of real GDP demanded by households, firms, and the government (both inside and outside of the country)
long run aggregate curve
a curve that shows the relationship in the long run between the price level and the quantity of real GDP supplied curves a vertical line
short run aggregate supply curve (upward sloping)
a curve that shows the relationship in the short run between the price level and the quantity of real GDP supplied by firms
On the long-run aggregate supply curve,
a decrease in the price level has no effect on the aggregate quantity of GDP supplied.
Why is the aggregate demand curve downward sloping?
a fall in the price level increases the quantity of real gdp demanded wealth effect interest rate effect the international trade effect
aggregate demand and aggregate supply model
a model that explains short-run fluctuations in real GDP and the price level fluctuations in real GDP and the price level are caused by shifts in the aggregate demand curve / aggregate supply curve
An increase in the expected future price level causes
a shift from B to A
An increase in the expected price of an important natural resource is indicated by
a shift from B to A
The ________ shows the relationship between the price level and quantity of real GDP demanded.
aggregate demand curve
The Monetarist Model
aka neo quantity theory of money model developed in 1940's by Milton Friedman the idea that the quantity of money should be increased at a constant rate argued that the Keynesian approach overstates the amount of macroeconomic instability in the economy also argued most fluctuations in real output were caused by fluctuations in money supply therefore, the federal reserve should concentrate less on interest rates and more on following a monetary growth rate, a plan for increasing the quantity of money at a fixed rate that doesn't respond to changes in economic conditions
Karl marx's theory of value
all the value of a good or service to the labor embodied in it market system will eventually be replaced by communist economy (workers control production) bc workers would rebel against exploitation by large firms, unable to afford an above subsitence standard of living
Which of the following will shift the aggregate demand curve to the right, ceteris paribus? A. a decrease in expected profits for firms B. a decrease in disposable income C. an increase in interest rates D. an increase in net exports
an increase in net exports
increases in the labor force and in the capital stock
as labor force and the capital stock grow, firms will supply more output at every price level and the SRAS will shift right decrease in labor force: SRAS will shift left
the recession of 2007-2009
began december 2007, ended with economic expansion in november 2001
fiscal policy
changes in federal taxes and purchases that are intended to achieve macroeconomic policy objectives
4 components of real GDP
consumption investment gov purchases net exports
Austrian Model
created by the austrian school of economics, advanced by ludwig von rises and fredwich von hayes argues for the superiority of the market system over economic planning particularly argued that only the price system could make use of all the dispersed info to achieve efficiency also developed a theory of the business cycle where in central bank induced low interest reared cause the business cycle by prompting over investment
The Wealth Effect: How a Change in the Price Level Affects Consumption
current income: most important variable determining consumption by households, but also depends on household wealth income rises= consumption rises, income falls = consumption falls implication: higher price level leads to lower consumption
Higher personal income taxes
decrease aggregate demand
The New Classical Model
developed in mid 1970's by group of economists the idea that workers and firms have rational expectations (they form their expectations of the future values of economic variables and use all available info) workers develop expectations abt price levels. if these expectations were wrong, then the real wage will be too high or too low, causing firms to reduce or increase employment respectively
real business cycle model
focuses on real, rather than monetary, causes of the business cycle adherents to this model also believe that workers and firms form rational expectations about prices and wages, which adjust quickly to supply and demand main source of fluctuations in real GDP: temporary productivity stocks
firms are often slow to adjust wages
if firms are slow to adjust wages, a rise in the price level will increase the profitability of hiring more workers and producing more output a fall in the price level: will decrease the profitability of hiring more workers and producing more output also, firms are slower to cut wages than to increase them
changes in expected future price level
if workers believe the price level's gonna increase by a certain percent they'l adjust wages and prices accordingly, resulting in a shift to the left so that any level of real GDP's now associated w a price level that _% higher
menu costs make some prices sticky
many firms base their prices partly on what they expect future prices to be and list the prices of their products on their website if they wanna change the price, they have to make new menus or adjust website a small optimal change in price may not be worth the hassle for a firm to perform
A change in the price level causes a ______ the short-run aggregate supply (SRAS) curve.
movement along
unexpected changes in the price of an important natural resource
oil prices effect a lot of things so when oil prices rise, so do all those things bc firms face rising costs they'll supply the same level of output only if they receive higher prices and curve will shift left expectation of higher price level: shift to left other factors: shift right
Refer to the figure to the right. Ceteris paribus, an increase in the price level would be represented by a movement from
point A to point B.
technological change
positive technological change = productivity of workers and machinery increases = firms can produce more goods and services, which reduces the firm's cost of production ad allows them to produce more output = SRAS shifts right
When the price level rises from 110 to 115, the aggregate level of GDP supplied rises from $80 billion to $120 billion. This ________ relationship represents the ________ relationship between the quantity of real GDP firms are willing to supply and the price level.
positive; short-run
movement along the AD curve:
price level changes but other variables that affect the willingness of households, firms and the government to spend are unchanged (up or down)
The long run aggregate supply curve shows the relationship between the ________ and ________.
price level; quantity of real GDP supplied
Potential GDP refers to the level of
real GDP in the long run
An improvement in technology is shown as a
shift from A to B
An increase in the labor force or capital stock is illustrated as a _____
shift from A to B
A change in any other factor causes a ______ the SRAS curve.
shift in
Suppose the U.S. GDP growth rate is faster relative to other countries' GDP growth rates. U.S. imports will therefore increase faster than U.S. exports, and this will
shift the aggregate demand curve to the left.
adjustments of workers and firms to errors in past expectations about the price level
sometimes incorrect predictions are made about the price level and will attempt to compensate for the errors if workers and firms across the economy are adjusting to the price level being higher than expected, the SRAS curve will shift left if they adjust lower than expected, it'll shift right
Short run agregate supply
tells us the short run relationship between the price level and quantity of goods and services firms are willing to supply, holding constant all other variables that affect the willingness of firms to supply goods and services if price level changes: up or down if any other variable besides price level changes: shift
monetary policy
the actions the Federal Reserve takes to manage the money supply and interest rates to achieve macroeconomic's policy objectives
Long-run macroeconomic equilibrium occurs when
the aggregate demand and short-run aggregate supply curves intersect at a point on the long-run aggregate supply curve.
changes in the expectations of households and firms
the aggregate demand curve slopes downward bc a higher price level reduces the real value of household wealth, which decreases consumption raises interest rates, which decreases investment and consumption makes U.S. exports more expensive and foreign imports less expensive, which decreases net exports
menu costs
the costs to firms of changing prices
wealth effect
the effect of the price level on consumption, one of the reasons aggregate demand curve's downward sloping
interest rate effect
the effect of the price level on investment and consumption
international trade effect
the effect of the price level on net exports
main factors that caused the recession
the end of the housing bubble the financial crisis rapid increase in oil prices during 2008
automatic mechanism
the process of adjustment back to potential GDP bc it occurs without any actions by the gov
Aggregate Supply
the quantity of goods and services that firms are willing and able to supply
short-run aggregate supply curve
upward sloping curve bc price level increases, quantity of goods and services firms are willing to supply will increase 2 reasons: as prices of final goods and services rise, prices of inputs- aka the wage of workers or the price of natural resources - rise more slowly some firms are slow to adjust their prices when the price level rises or falls
the international trade effect
when US price levels rise, US exports become more expensive and imports become relatively cheaper fewer exports and more imports = net exports fall
shift along the AD curve:
when any other variable that's not the price level changes (ex. change in gov purchases)
An increase in the price level results in a(n) ___________ in the quantity of real GDP demanded because ___________.
decrease; a higher price level reduces consumption, investment, and net exports.
The automatic mechanism _________ the price level in the case of ________ and ________ the price level in the case of ________.
lowers; recession; raises; expansion
The short run aggregate supply curve has a(n) ________ slope because as prices of ________ rise, prices of ________ rise more slowly.
positive; final goods and services; inputs
