Chapter 15 - Aggregate Demand and Aggregate Supply

What events shift the aggregate Demand Curve?

1. Changes in Consumption: economy-wide changes in consumption habits shift the demand curves 2. Changes in Investment: If all companies upgraded to new technology, this would increase overall demand and shift the curve to the right. 3. Money supply: increases in money supply lowers the interest rate and stimulates borrowing and spending (in the short run). 4. Changes in Gov't spending: changes in the level of spending shifts the demand curve.

What are the 3 key facts about economic fluctuations?

1. Economic fluctuations are irregular and unpredictable 2. Most Macroeconomic quantities fluctuate together 3. As output falls, unemployment rises

What variables shift both the short run aggregate supply curve and the long run aggregate supply curve?

1. Increase in capital 2. Increase in technology 3. Increase in labor or natural resources 4. Increases in minimum wages 5. Reduced Wages (to the right)

Explain 3 theories for why the short-run aggregate supply curve is upward sloping

1. Sticky Wages 2. Sticky Prices 3. Misconceptions Theory

Explain the three reasons the aggregate-demand curve sloped downward?

1. The Wealth effect: As prices drop, the real value of money rises and encourages consumers to buy more. That creates more demand at lower prices. 2. The Interest-Rate effect: A lower price reduces interest rate, encouraging greater spending on investment goods. This increases the quantity of goods and services demanded at the lower prices. 3. The Exhange-Rate Effect. Falls in the price level and interest rates of the US Cause the $$ to depreciate. This stimulates US net exports and increase the quantity of our goods and services demanded.

What are the Effects of a shift in Aggregate demand in the short run and the long run?

A decrease in demand in the short run, causes the price level to fall and output to fall. Over time, the supply curve will shift to the right restoring the supply, but dropping the equilibrium price level. An increase in demand in the short run, causes the price level to rise and output to increase. Over time, the supply curve will shift back to the left and cause a higher equilibrium price level at the same supply level.

What are the Effects of a shift in Aggregate Supply in the short run and the long run?

A decrease in the supply in the short run, causes the short run supply curve to shift to the left Raising the price level and reducing output. If left alone, the supply curve shifts back to the original position.

What is the interest rate effect?

A lower price level reduces the quantity of money households demand; The increase in savings drops the interest rate which stimulates investment spending

What is Stagflation?

A period of falling output and rising prices. (When supply decreases)

What might shift the AS curve to the left?

A reduction of labor, natural resources, capital, people's expectation of a higher price level.

The Sticky-Price Theory

A theory that states short run aggregate supply curve slopes upward because prices are slow to adjust to changes in the economy. Also, menu prices cause the changes to be costly.

The Sticky-Wage Theory

A theory that states short run aggregate supply curves slopes upward because wages are slow to adjust the changes in the economy

What is the exchange rate effect?

As lower price level reduces interest rates, the dollar depreciates in the market for foreign-currency exchange, which stimulates net exports.

Misperceptions Theory

Changes in overall price levels can mislead suppliers about the state of the individual markets to whom they sell their output. They respond to their perceptions and cause the curve to slope.

monetary neutrality

Changes in the money supply do not affect real variables

What causes the Aggregate supply curve to be horizontal?

High Employment

What does the Laffer curve show?

How supply side economics works

How does the economy's behavior in the short run differ from it's behavior in the long run?

In the short run, monetary neutrality is not reality. The classical theory does not work in the short run.

If the central bank increases the money supply, what happens to output and the price level as the economy moves from the initial to the new short-run equilibrium?

Increase demand curve to the right raises the price level in the short run and increases output in the short run. As supply moves back to equilibrium, the price level stays high and output goes back to natural level.

How does an increase of unemployment rate shift the SAS and LAS curves?

Increases shift both the Short and Long Run AS curves to the left. (Less employment causes less output)

Which component of AD is most volatile over the business cycle?

Investment

What does an increase in NCO do to the US exchange rate?

It depreciates, US dollar is not worth as much. Increases net exports as foreigners want to buy cheaper goods

What does a lower US interest Rate to NCO?

It increases NCO as people invest abroad

What does a lower price in the US do to US interest rates?

Lowers them, more people savings

How can policy makers potentially mitigate stagnation?

Policy makers can only make the price permanently rise when they increase demand to keep the supply rate steady. This is said to accommodate the shift in aggregate supply and therefore raising prices permanently

Why is the long-run aggregate Supply curve Vertical?

Prices do not affect the supply in the long run causing the curve to be vertical.

Name 2 macroeconomic variables that decline when the economy goes into a recession. What one variable rises?

Read GDP and investment spending decline, unemployment rises.

What might shift the AD curve to the left?

Reduced consumption economy wide, decreased supply of money, reduced government spending

Does a shift in the AD demand or AS supply curve return to the normal level of price/quantity over time?

Shifts in the AS curve shift back over time. Shifts in the AD curves result in a permanent price level change as supply adjusts to the new demand level.

Increases in the money supply affect the AD curve how?

Shifts to the left - more buying

What is supply side economics?

Stresses incentives to work, save and invest

What is the horizontal portion of the Aggregate supply curve called?

The Keynesian Range

What variables shift only the short run aggregate supply curve?

The expected price level that people have. If people expect the prices to rise, they will demand more wages, costs will go up and firms will produce less. This causes the supply curve to shift left. The opposite is true for expectation of lowered prices.

What Variables are on the aggregate axes?

X axis: GDP Y axis: CPI or other price level indicator

6. Explain whether each of the following events will increase, decrease, or have no effect on long-run aggregate supply: a) The U.S. experiences a wave of immigration. b) The United Auto Workers Union wins an unexpectedly high wage increase in its new contract. c) Intel invents a new and more powerful computer chip. d) A severe hurricane damages factories along the east coast.

a. LAS shifts to the right b. LAS does not shift c. LAS shift to the right, increased technology d. Cost of business increases, suppliers lay off. LAS shifts to the left