Aggregate Supply and Demand

Why the Aggregate demand curve might shift?

-changes in consumption: stock market boom/crash, tax hikes/cut -changes in investment: financial friction: between leaders and borrowers -> moral hazard ad adverse selection, not a lot of trust -changes in government purchases: federal spending e.g. defense-> increase -> AD goes to the right -changes in net exports: Booms/recessions in countries that buy our exports

Use the theory of liquidity preference to explain how an increase in the money supply affects the equilibrium interest rate. How does this change in monetary policy affect the aggregate demand curve?

According to the theory of liquidity preference, the interest rate adjusts to balance the supply and demand for money. Therefore, a decrease in the money supply will increase the equilibrium interest rate. The increase in the money supply will lead to an increase in consumer spending. This increase will shift the aggregate-demand curve to the right.

If the labor force becomes more productive over time, how would the long-run aggregate supply curve be affected?

As labor productivity grows overtime, the long-run aggregate supply curve shifts to the right. This is because the existing labor force, along with a given amount of capital and other resources, is able to produce more output, which indicates a greater amount of potential output.

The U.S. exchange rate falls

Depreciation, NX will increase, AD curve shifts right

What factors shift the short-run aggregate supply curve? Do any of these factors shift the long-run aggregate supply curve? Why?

Factors that shift the short-run aggregate supply curve are taxes and subsidies, the price of labor (wages), and the price of raw materials. The changes in quantity and quality of labor and capital also can influence the curve. Yes, the quantity of labor and capital both influence the short-run and long-run aggregate supply curve. For example, if there is an increase in the number of available workers or labor hours in the long run, the aggregate supply curve will shift outward (it is assumed the labor market is always in equilibrium and everyone in the workforce is employed). Similarly, changes in technology can shift the curve by changing the potential output from the same amount of inputs in the long-term (Boundless Economics).

decrease in aggregate demand

Government spending decreases, taxes increase, consumption decreases, financial friction decreases

A fall in prices increases the real value of consumers' wealth

Hold prices constant

Using Aggregate Demand and Aggregate supply to analyze the Great Recession

In considering the causes of the Great Recession, most economist and policy makers initially assumed it was caused by a significant decline in aggregate demand. But aggregate supply also fell. - The decline in aggregate supply was caused by problems with a key economic institution: the loanable funds market and U.S. real estate

What will happen to the AD curve if: A ten year old investment tax credits expires

Investment will decrease, AD falls, curve shifts left

State governments replace their sales taxes with new taxes, or interest, dividends, and capital gains

Taxes go down, aggregate demand increases

Draw the short-run trade-off between inflation and unemployment. How might the Fed move the economy from one point on this curve to another?

The Fed can move the economy from one point on this curve to another by changing the money supply. An increase in the money supply reduces the unemployment rate and increases the inflation rate, while a decrease in the money supply increases the unemployment rate and decreases the inflation rate.

List and explain the three theories for why the short-run aggregate-supply curve slopes upward.

The Sticky-Wage Theory, the sticky-price theory, and the misperceptions theory. The sticky-wage theory states that the short-run aggregate supply curve slopes upward because nominal wages are slow to adjust to changing economic conditions (wages are "sticky" in the short-run). The sticky-price theory emphasizes that the prices of some goods and services also adjust sluggishly in response to changing economic conditions. This slow adjustment of prices occurs in part because there are costs to adjusting prices (menu costs). AS a result of these costs, prices as well as wages are sticky in the short run. The misperceptions theory states that changes in the overall price level can temporarily mislead suppliers about what is happening in the individual markets in which they sell their output. As a result of these short-run misperceptions, suppliers respond to changes in the level of prices, and this response leads to an upward-sloping aggregate supply-curve.

Explain why the long-run aggregate supply curve is vertical. What might shift the aggregate supply curve to the left?

The long-run aggregate supply curve is vertical which reflect economists' belief that the changes in aggregate demand only cause a temporary change in an economy's total output. The aggregate supply curve shifts to the left as the price of key inputs rises, making a combination of lower output, higher unemployment, and higher inflation possible. When an economy experiences stagnant growth and high inflation at the same time it is referred to as stagflation. (Khan Academy).

List and explain the three reasons why the aggregate-demand curve slopes downward. What might shift the aggregate-demand curve to the left?

The three reasons are Pigou's wealth effect, Keynes's interest-rate effect, and Mundell-Fleming's exchange-rate effect. The reason for the wealth effect is because when the price level falls, consumers are wealthier which causes consumers to spend more. For the interest-rate effect, a lower price level reduces the amount of money people want to hold. As people try to lend out their excess money holdings, the interest rate falls. The lower interest rate stimulates investment spending and thus increases the quantity of goods and services demanded. The exchange rate effect is when a lower price level reduces the interest rate, investors move some of their funds overseas in search of higher returns. This movement of funds causes the real value of the domestic currency to fall in the market for foreig-currency exchange. Domestic goods become less expensive relative to foreign goods. This change in real exchange rate stimulates spending on net exports and this increases the quantity of goods and services demanded. The aggregate-demand curve might shift to the left when total consumer spending declines. They might spend less because the cost of living is rising or the government could have increased taxes.

Name two macroeconomic variables that decline when the economy goes into a recession. Name one macroeconomic variable that rises during a recession

Two macroeconomic variables that decline when the economy goes into a recession are real GDP and investment spending. The reason for this is because as the economy faces recession, there would be a fall in the value of the money resulting in less investment. One macroeconomic variable that rises during a recession is unemployment.

If the unemployment rate is above the natural rate of unemployment, holding other factors constant, what will happen to inflation and output?

When the unemployment rate is above the natural rate of unemployment, there is slack in the labor market and output is below potential. This causes the short-run aggregate supply curve to shift downward, leading to lower inflation and higher output over time, until the economy reaches a long-run equilibrium.

The Great Recession

severe ongoing global economic problem that began in December 2007 and took a particularly sharp downward turn in September 2008; has affected the global economy, with higher detriment in some countries than others; sparked by the outbreak of the late-2000s financial crisis