Chapter 24: From the Short Run to the Long Run

A recessionary gap may be closed by?

A (slow) downward shift of the AS curve or an increase in aggregate demand

How does a a negative AD shock change prices and output?

A negative AD shock first lower the price level and GDP along the AS curve and then induces a (possibly slow) shift of the AS curve that further lowers prices but raises output along the new AD curve

How does a positive AD shock change prices and output?

A positive AD shock first raises prices and output along the AS curve. It then induces a shift of the AS curve that further raises prices but lowers output along the new AD curve

When the economy's adjustment process is slow to operate, or produces undesirable side effects such as rising prices, there is?

A potential stabilization role for fiscal policy

Reductions in tax rates generate?

A short-run demand stimulus and may also generate a longer-run increase in the level and growth rate of potential output

The output gap is the difference between?

Actual GDP and potential GDP, Y - Y*

Flexible wages that fall rapidly in the presence of a recessionary gap provide?

An automatic adjustment process that pushes the economy back quickly toward potential output

Even in the absence of discretionary fiscal stabilization policy, the government's tax-and-transfer system provides?

An automatic stabilizer to the economy

An inflationary gap may be removed by?

An upward shift of the AS curve or by a leftward shift of the AD curve

Any output gap is assumed to cause wages and other factor prices to adjust, eventually bringing the equilibrium level of output?

Back to potential; the level of potential output therefore acts like an "anchor" for the economy

Following an AD or AS shock, the short-run equilibrium level of output may be?

Different from potential output

Automatic stablizers

Elements of the tax-and-transfer system that reduce the responsiveness of real GDP to changes in autonomous expenditure

The adjustment in wages and other factor prices eventually?

Eliminates any inflationary gap caused by a demand shock; real GDP returns to its potential level

Potential output determines the long-run equilibrium value of?

GDP

Recessions usually cause wages to fall?

Only slowly

Phillips curve

Originally, a relationship between the unemployment rate and the rate of change of nominal wages; now often drawn as a relationship between GDP and the rate of change of nominal wages

Booms can cause wages to rise?

Rapidly

A negative AS shock caused by an increase in input prices causes?

Real GDP to fall and the price level to rise. The economy's adjustment process then reverses the AS shift and eventually returns the economy to its starting point

If an increase in government purchases leads to an increase in potential output (or its growth rate), the negative effects from the crowding out of private investment will be?

Reduced

If wages are downwardly sticky, the economy's adjustment process is?

Sluggish and thus will not quickly eliminate a recessionary gap

Fine tuning

The attempt to maintain output at its potential level by means of frequent changes in fiscal or monetary policy

Stagflation

The combination of a fall in GDP and an increase in the price level

The paradox of thrift

The idea that an increase in saving reduces the level of GDP

Phillips relationship

The negative relationship between unemployment and the rate of change in wages

Decision lag

The period of time between perceiving some problem and reaching a decision on what to do about it

Given Y*, aggregate demand determines the long-run equilibrium value of?

The price level

Long-run aggregate supply curve

The relationship between the price level and the amount of output supplied by firms after all factor prices have adjusted to output gaps

The paradox of thrift is only true in?

The short run. In the long run, the path of real GDP is determined by the path of potential output. The increase in saving has the long-run effect of increasing investment and therefore increasing potential output

Both upward and downward adjustments to wages and unit costs do occur, but there are differences in?

The speed at which they typically operate

Execution lag

The time that it takes to put policies in place after a decision has been made

Gross tuning

The use of macroeconomic policy to stabilize the economy such that large deviations from potential output do not persist for extended periods of time

Exogenous changes in input prices cause the AS curve?

To shift, creating an output gap. The adjustment process then reverses the initial AS shift and brings the economy back to potential output and the initial price level

The slump that is associated with a recessionary gap generates a set of conditions - low profits for firms and an excess supply of labour - that tends to cause?

Wages (and other factor prices) to fall

The boom that is associated with an inflationary gap generates a set of conditions - high profits form firms and an excess demand for labour - that tends to cause?

Wages (and other factor prices) to rise

Long-run equilibrium (in terms of AD, AS, and Y*)

When the intersection of the AD and AS curves occurs at Y*

In the long run, real GDP is determined solely by?

Y*; the role of aggregate demand is only to determine the price level