Macro ch 15

What causes the economy to move from its short-run equilibrium to its long-run equilibrium?

Nominal wages, prices, and perceptions adjust upward to this new price level.

According to the misperceptions theory, the economy is in a recession when the price level is

below what was expected Over time, as people observe the lower price level, their expectations adjust, and the economy returns to the long-run aggregate-supply curve.

An economy could enter a recession if either the aggregate-demand curve or the short-run aggregate-supply curve were to shift to the

left

According to the sticky-price theory, the economy is in a recession because

not all prices adjust quickly Over time, firms are able to adjust their prices more fully, and the economy returns to the long-run aggregate-supply curve.

The long-run aggregate-supply curve is vertical because

the price level does not affect long-run aggregate supply BUT Economic forces of various kinds (such as population and productivity) do affect long-run aggregate supply

A change in the expected price level shifts

the short-run aggregate-supply curve.

A stock market crash, or any event that causes consumers to cut back in spending and firms to cut back in their investments, reduces aggregate demand at any given price level

(causes a shift in the aggregate demand curve)

Suppose the economy is in a long-run equilibrium, then experiences a stock market crash causing aggregate demand to fall.

A stock market crash leads to a leftward shift of aggregate demand. The equilibrium level of output and the price level will fall. Because the quantity of output is less than the natural rate of output, The unemployment rate will rise above the natural rate of unemployment.

Suppose an economy is in long-run equilibrium. The central bank raises the money supply by 5 percent. What happens to output and the price level as the economy moves from the initial to the new short-run equilibrium?

Aggregate supply and demand both increase If the central bank increases the money supply, the aggregate demand curve shifts to the right, with the new short-run equilibrium. Thus, in the short run, both output and the price level increase. Over time, as nominal wages, prices, and perceptions adjust to the new price level, the short-run aggregate-supply curve shifts to the left, returning the economy to the natural rate of output

Use the sticky-wage theory of aggregate supply to think about what will happen to output and the price level in the long run (assuming there is no change in policy).

If nominal wages are unchanged as the price level falls, firms will be forced to cut back on employment and production. Over time, as expectations adjust, the short-run aggregate-supply curve will shift to the right, moving the economy back to the natural rate of output.

The idea that economic downturns result from an inadequate aggregate demand for goods and services is derived from the work of which economist?

John Maynard Keynes

Events that will increase Long-Run Aggregate Supply

The United States experiences a wave of immigration, which increases the labor force (curve shifts to the right) Intel invents a new and more powerful computer chip, productivity increases, so long-run aggregate supply increases because more output can be produced with the same inputs.

A change in the expected price level shifts the short-run aggregate-supply curve. If people expect lower prices in the future, they will accept lower wages (that is, supply more labor for any given price level) and set lower prices (or produce more output at any given price level).

This would be reflected in a rightward shift of the short-run aggregate-supply curve.

Events that will decrease Long-Run Aggregate Supply

When Congress raises the minimum wage to $10 per hour, the natural rate of unemployment rises, so long-run aggregate-supply decreases (curve shifts to the left). When a severe hurricane damages factories along the East Coast, the capital stock is smaller, so long-run aggregate supply decreases.

The aggregate-demand curve slopes downward because

a fall in the price level raises the overall quantity of goods and services demanded through the wealth effect, the interest-rate effect, and the exchange-rate effect.

Stagflation is caused by

a leftward shift in the aggregate-supply curve.

According to the sticky-wage theory of aggregate supply, nominal wages at the initial equilibrium are ___________ to nominal wages at the short-run equilibrium resulting from the increase in the money supply, and ____________ nominal wages at the long-run equilibrium.

equal to, less than

When the economy goes into a recession, real GDP ________, and unemployment ________.

falls, rises A recession is a period of economic contraction rather than growth. During such periods, the economy produces fewer goods and services; thus, real GDP falls and unemployment rises.

Real wages at the initial equilibrium are ____________ real wages at the short-run equilibrium resulting from the increase in the money supply, and ______________ real wages at the long-run equilibrium. Judging by the impact of the money supply on nominal and real wages.

greater than, are equal to This analysis is consistent with the proposition that money has real effects in the short run but is neutral in the long run.

According to the sticky-wage theory, the economy is in a recession because the price level has declined so that real wages are too ___________; thus, labor demand is too __________

high, low Over time, as nominal wages are adjusted so that real wages decline, the economy returns to full employment.

An increase in the aggregate demand for goods and services has a larger impact on output ________ and a larger impact on the price level ________.

in the short run, in the long run An increase in aggregate demand affects output in the short run. In the long run, however, an increase in aggregate demand has no impact on output and affects only the price level, as wages and prices adjust to bring output back to the natural rate of output.

A sudden crash in the stock market shifts

the aggregate demand curve.

Stagflation is a period of time where output is falling and prices are rising. When firms experience an increase in the costs of production, selling goods becomes less profitable, and firms supply less output at any given price level. This causes

the aggregate-supply curve to shift to the left, resulting in lower output and a higher price level.

If firms adjusted prices quickly and if sticky prices were the only possible cause for the upward slope of the short-run aggregate-supply curve, then the short-run aggregate-supply curve would be

vertical, not horizontal The short-run aggregate-supply curve would be horizontal only if prices were completely fixed