econ chapter 20 and chapter 21

Change Needed to Increase AD 1) Consumer expectations about future profitability 2) Government spending 3) Expected rate of return on investment 4) Incomes in other countries

!) improve 2) increase 3) increase 4) increase Explanation: Consumer spending is influenced, in part, by consumer expectations. If households expect strong economic growth and higher earnings, they will spend more today. The increase in current consumption causes an increase in aggregate demand at each price level. Because government purchases are one component of aggregate demand, an increase in government spending causes aggregate demand to increase at each price level. The rate of return that businesses expect on capital projects is a key determinant of investment. Suppose a technological breakthrough causes an increase in the expected return on investment. Investment spending will rise, and aggregate demand will increase at each price level. When the incomes of foreigners increase, foreigners will purchase more domestic products, causing exports to rise. Because net exports are one component of aggregate demand, this increase in net exports (exports minus imports) leads to an increase in aggregate demand at each price level.

The aggregate demand curve is also known as the

AD curve

changes in C can occur because of

-Stock market boom/crash -Preferences : consumption/saving tradeoff -Tax hikes/cuts

Changes in NX can occur because of

-Booms/recessions in countries that buy our exports -Appreciation/depreciation resulting from international speculation in foreign exchange market

changes in G can occur because of

-Federal spending, e.g., defense -State & local spending, e.g., roads, schools

Changes in I can occur because of

-Firms buy new computers, equipment, factories -Expectations, optimism/pessimism -Interest rates, -Monetary policy, -Investment Tax Credit or other tax incentives

Extra notes:

A recession is a period of declining real GDP. The technical definition of recession is "a period of falling real GDP that lasts 6 months or more." The short-term fluctuations in real GDP are irregular and unpredictable. Recessions may occur close together or farther apart. The duration of recessions varies, and output tends to rise and fall at different rates over time. The ups and downs in real GDP are known as the business cycle, but this term is somewhat misleading because economic fluctuations do not follow a regular cycle.

Which of the following probably occurred as the U.S. economy experienced increasing real GDP: pick all that apply a) Consumer spending increased. b) The unemployment rate declined. c) Retail sales increased. d) Home sales declined.

A,B, and C Explanation: Most macroeconomic quantities fluctuate together. Recall that real GDP measures the economy's total output and total income simultaneously. A decrease in real GDP, therefore, coincides with declining total income, declining personal income, and falling corporate profits. As incomes decline during a recession, so, too, does consumer spending on retail goods and services and on durable goods, such as automobiles. Households also contribute to declining investment expenditures by purchasing fewer new homes. As households spend less on products, firms cut back on industrial production and curb investment expenditures on physical capital. The unemployment rate tends to rise during periods of falling real GDP as firms cut back on production and lay off workers. The unemployment rate tends to fall during economic expansions as firms expand production and hire additional workers.

Y=C+I+G+NX equals

Aggregate demand, assume G is fixed by govt policy

What happens to the AD curve if State governments replace their sales taxes with new taxes on interest, dividends, and capital gains.

C rises and the AD curve shifts right

A stock market boom makes households feel wealthier, What happens on the aggregate demand curve

C rises, the AD curve shifts right.

Shifts in the AD curve can be a factor of changes in

C,I,G, or NX

Any event that changes __ , __, __, or ____ —except a change in __—will __________ the AD curve.

C,I,G, or NX, P, shift

Classical theory

Describes the world in the long run, but not the short run

the neutrality of money

changes in the money supply affect nominal but not real variables

What happens to the AD curve if A ten-year-old investment tax credit expires

I falls, the AD curve shifts left

In the exchange rate effect when the U.S. dollar depreciates what happens to imports and exports

Imports decrease and exports increase

What happens to to the AD curve if The U.S. exchange rate falls.

NX rises and the AD curve shifts right

to understand the slope of Aggregate demand one must determine how a change in ______ affects __, ___, and ____

P; C,I,NX

The wealth affect concerns

Price and consumption

The interest rate affect concerns

Price and investment

A

Technology

Extra notes:

The following graph shows the short-run model of aggregate demand and aggregate supply. The price level, a nominal variable, is on the vertical axis, and the quantity of output, a real variable, is on the horizontal axis. The downward-sloping aggregate demand curve shows the quantity of output that governments, consumers, business firms, and foreign customers wish to buy at each price level. The upward-sloping aggregate supply curve shows the quantity of output that firms produce and sell at each price level.

The aggregate demand and Aggregate supply model differs from

classical economic theories economists use to explain the long run

In the exchange rate effect if p decreases

There is a decrease in the interest rate r which encourages US savers to buy foreign stocks & bonds and sell $ to buy foreign currencies. The U.S. dollar depreciates and imports decrease as exports increase which stimulates U.S. net exports, and increases nx and Increase in quantity demanded of goods and services Y

True or False: Short-term fluctuations in real GDP are irregular and unpredictable.

True

In the exchange rate affect when there is a decrease in the interest rate what happens

U.S savers buy foreign stocks and bonds and sell $ to buy foreign currencies

example of real variables

Y/ Real GDP or the unemployment rate

A period of declining real GDP is known as

a recession

in the short run changes in nominal variables can

affect real variables

any changes leading to increasing C, I, G, or NX lead to

an increase in AD (so the AD curve shifts right)

wealthier consumers leads to

an increase in the quantity demanded of goods and services

In the interest rate affect an increase in P causes

an increases in interest rates which decreases investment

U.S. interest rates rise (the interest-rate effect); Foreign investors desire more U.S. bonds; Higher demand for $ in foreign exchange market; U.S. exchange rate appreciates; U.S. exports more expensive to people abroad, imports cheaper to U.S. residents. Result: NX falls. what does this situation describe?

and increase in price level concerning the exchange rate affect

If Price decreases in the wealth affect then consumers

become wealthier

In the interest rate affect when buying goods and services require fewer dollars people will

buy bonds and other assets and the supply of loanable funds will increase

The interest rate affect says that if P declines then

buying Goods and services requires fewer dollars which means people will buy bonds and other assets and the supply of loanable funds increases which leads to a decrease in the interest rate (r) and an increase in spending on investment goods (I) and an increase in the quantity demanded of goods and services (Y)

k

capital

Increased government spending is likely to

cause a rise in aggregate demand

A change in P won't shift the AD curve but it will

cause movements along the curve

In the interest rate affect when people buy bonds and other assets and the supply of loanable funds increases the interest rate

decreases

Recessions are of

different durations and do not occur with any regularity

Additionally, as the price level falls, the impact on the domestic interest rate will cause the real value of the dollar to ______ in foreign exchange markets. The number of domestic products purchased by foreigners (exports) will therefore _______ , and the number of foreign products purchased by domestic consumers and firms (imports) will ________ . Net exports will therefore ________ , causing the quantity of domestic output demanded to _______ . This phenomenon is known as the __________

fall, rise, fall, rise, rise, the exchange rate affect Explanation: When an economy's price level falls, consumers require less money to purchase a given basket of goods and services, so that money demand falls, causing the domestic interest rate to fall. Investors respond to lower domestic interest rates by seeking higher returns abroad. As domestic investors attempt to convert dollars into foreign currency to buy foreign assets, the supply of dollars increases in the market for foreign-currency exchange, and the real value of the dollar falls. When each dollar buys fewer units of foreign currencies, foreign goods become more expensive than domestic goods. Because of dollar depreciation, foreigners find domestic goods to be relatively inexpensive. Exports of domestic goods to foreigners therefore rise, while domestic imports of foreign goods fall. Net exports (exports minus imports) therefore rise, leading to a rise in the quantity of domestic output demanded. The tendency for a fall in the price level to decrease the real exchange rate and increase net exports is known as the exchange rate effect.

As the price level falls, the cost of borrowing money will _________ , causing the quantity of output demanded to ________ . This phenomenon is known as the ______________

fall, rise, interest rate affect Explanation: If the price level falls, people will need less money to carry out day-to-day transactions. As people demand less money, the cost of borrowing money—the interest rate—will fall (assuming that the quantity of money in the economy is fixed). As a result, business investment speeds up, leading to an increased demand for domestic output. This is known as the interest rate effect of a change in the price level. Note that a lower interest rate increases not only investment spending, but also consumer spending, as people will want to save less. So, at a lower interest rate, business investment increases and household saving decreases, leading to an increased demand for domestic output.

most macroeconomic quantities

fluctuate together

GDP in the short run

fluctuates around its trend

real GDP in the long run

grows about 2% to 3% per year on average

H

human capital

The wealth affect

if P decreases there will be an increase in the real value of money (1/p) and consumers become wealthier which increases the quantity demanded of goods and services (Y)

When the economy is in a recession,

incomes fall, consumer spending falls, profits fall, many stock prices fall, tax revenue falls (causing the budget deficit to rise), and spending on imports falls (causing the trade deficit to shrink).

An increase in foreign incomes

increases aggregate demand and net exports

an increase in household demands for bonds causes

interest rate to fall

In the exchange rate affect when price level increases what happens?

interest rates and exchange rates increase and net exports decrease

In the Interest rate affect when interest rate increases

investment decreases

Economic fluctuations are ___________ and ___________

irregular and unpredictable

The wealth affect concerns the impact of the change in P on

wealth not income; when P falls we assume that peoples income is unchanged

L

liquidity

example of nominal variables

money supply or price

What happens to the AD curve if a fall in prices increases the real value of consumers' wealth.

movement down the AD curve (the wealth affect)

as firms increase their output, they

need more workers

In the exchange rate affect when imports decrease and exports increase what happens to net exports

net exports increase

an increase in the money supply, a__________variable, will cause the price level, a ____________ variable, to increase but will have no long-run effect on the quantity of goods and services the economy can produce, a _________ variable. The distinction between real variables and nominal variables is known as the _____________.

nominal, nominal, real, classical dichotomy Explanation: Real variables measure quantities of goods and services, such as the quantity of a particular good or service produced in an economy or the number of units of one good a unit of another good can buy. Nominal variables, such as the quantity of money or the price level, are measured in terms of dollars. The classical dichotomy is the separation of economic variables into real variables (those that measure quantities or relative prices) and nominal variables (those measured in terms of money).

N

number of workers employed

The exchange rate affect concerns

p and nx

In the interest rate affect when there is an increase of spending on investment goods there is an increase in

quantity demanded of goods and services

the horizontal axis of the aggregate demand and aggregate supply model measures the overall

quantity of output

The interest rate affects assumes that

real income (and everything else) is constant

Recessions are periods where

real incomes are falling and unemployment is rising

real wealth

real purchasing power as expressed in the amount of goods that you can purchase

Real Gdp growth in the long run depends on

real things such as L,K,N,H, and A

If price increases in the wealth affect then

real wealth decreases, consumers become less wealthy, and consumption drops

The wealth affects considers the impact of change in terms of

real wealth on consumption spending

2 consecutive quarters of declining Gdp growth is defined as a

recession

What is used to describe a period when , incomes fall, consumer spending falls, profits fall, many stock prices fall, tax revenue falls (causing the budget deficit to rise), and spending on imports falls (causing the trade deficit to shrink).

recession

Investment falls during

recessions

During each recession, the unemployment rate________ because when When firms cut back on production, they ______________

rises, they don't need as many workers

Depressions are

severe recessions and they are very rare

A change in P won't

shift the AD curve

in the interest rate affect when the interest rate decreases there will an increase in

spending on investment goods

The aggregate ____________ curve shows the quantity of goods and services that firms produce and sell at each price level.

supply

Most economists use _________________ to study fluctuations

the aggregate demand and aggregate supply

When tax revenue falls it causes

the budget deficit to rise

The model of aggregate demand and supply determines

the equilibrium price and quantity of everything; the price level (cost of living) and real GDP (national income

The green arrow on the aggregate demand curve graph is not equal to the fall in I but is equal to

the fall in demand due to the fall in I

The red arrow on the aggregate demand curve graph is not equal to c but is equal to

the fall in demand due to the fall in c

The brown arrow on the aggregate demand curve graph in not equal to the fall in nx but is equal to

the fall in demand due to the fall in nx

the graph of aggregate supply and aggregate demand measures

the nominal variable (p) on the vertical axis and the real one (y) on the horizontal axis

In the exchange rate affect what happens to the quantity demanded of goods and services when price level decreases

the quantity demanded of goods and services increases

The AD curve shows

the quantity of all goods and services demanded in the economy at any given price level.

If price decreases in the wealth affect then there will be an increase in

the real value of money and the quantity demanded of goods and service

The Classical Dichotomy

the separation of variables into two groups; Real and nominal

The wealth effect, interest rate effect, and exchange rate effect are all explanations for

the slope of aggregate demand curve

The AS curve shows

the total quantity of goods and services firms produce and sell at any given price level.

When spending on imports falls it causes

the trade deficit to shrink

during expansions, we see

the unemployment rate falling

as output falls

unemployment rises

The AS curve is

upward-sloping in short run and vertical in long run

nominal variables are

variables measured in monetary units/ measured in terms of money

Real variables are

variables measured in physical units; quantities and relative prices

The slope of the aggregate demand curve: An increase in P reduces the quantity of goods and services demanded because (in terms of wealth effect, the interest rate effect, and the exchange rate affect)

•the wealth effect (C falls) •the interest-rate effect (I falls) •the exchange-rate effect (NX falls)