Chapter 11

What kind of movements does a NON-PRICE changes make?

A SHIFT in the entire demand curve.

What is the ONLY change in the long run that the a DEMAND shock can have?

A change in price, outputs eventually return back to its long-run potential level.

What is the difference between aggregate demand and aggregate supply?

- Aggregate supply operates differently in the short run and in the long run → there are two different aggregate supply curves: one is the Long Run Aggregate Supply curve (LRAS); the second is the Short run Aggregate supply curve (SRAS).

What is likely to cause a temporary supply shock?

- shocks to do with prices,

What can cause the demand curve to shift to the right?

-increase in consumer and business confidence. - cutting taxes increases consumer spending → feel wealthier - increase government spending → direct effect - new free trade agreement and reduce tarrifs - economic growth abroad in China increases demand for US goods and services

What is the aggregate demand curve?

A curve that shows the relationship between the overall price level in the economy and total demand.

What kind of movements do price changes make?

A movement ALONG the demand curve.

Define Stagflation.

A situation in which OUTPUT DECREASES, AND PRICES INCREASE; usually coupled with inflation. `

What happens in the long run when the economy experiences a NEGATIVE shock?

AD shifts to the left, OUTPUT REMAINS THE SAME, but prices FALL.

What happens in the short run when the economy experiences a NEGATIVE shock?

AD shifts to the left, output and prices decreases.

What is the difference between an increase in cost of production and increase in price level?

An increase in the cost of production shirts the SRAS curve leftward, reducing quantity of output produced at a given price level. An increase in the price level itself → the weighted average of the prices of all goods and services we produce → would cause us to move from one point on the SRAS curve to another point on the same (unmoving) curve.

What is likely to cause a PERMANENT supply shock?

Any change to the inputs → cataclysmic climate change.

What will cause the LRAS curve to shift?

Anything that affects the output possible using the factors: technologies, improved transportation systems, management innovations, etc. will shift the curve.

Why does the short run aggregate supply curve slope upwards?

As overall price levels rise, firms are willing to produce more.

Why is it hard to get out of stagflation?

Because of stick input prices.

As overall price levels rise, firms are willing to produce more. Why?

Because the prices of final goods and services tend to increase faster that the prices of inputs → PRICES ARE STICKY. → firms are able to increase revenues faster than costs, and want to produce more.

What causes short run aggregate supply curve to shift?

Changes in input prices. → supply shocks, significant events that directly affect production and the aggregate-supply curve in the short run.

Why are input prices sticky? When the price of final goods and services can change instantaneously?

Contracts or informal practices make wages and the price of other inputs sticky.

Define business cycle.

Fluctuations of output around the level of potential output in the economy.

Why does the aggregate demand curve slop downward?

GDP = OUTPUT = NATIONAL EXPENDITURE = C + I + G +NX: 1) CONSUMPTION (C): Changes in price level will change the REAL value of peoples wealth and income → increase in overall prices, reduce peoples wealth, in terms of real purchasing power. → When people are less wealthy, they consume less creating a NEGATIVE RELATIONSHIP BETWEEN consumption and overall price level → wealth effect. NOTE: if wages increase the same amout as prices does, the purchasing power of those wages stay the same. 2) INVESTMENT (I): when prices rise, the interest rate (price or borrowing) rises too. Higher interest rates leads to less investments. → increase in borrow costs create an INDIRECT negative relationship between the price level and investment spending. 3) GOVERNMENT SPENDING: The government has NO EFFECT on the negative slopping of the demand curve. 4) NET EXPORTS: When the prices in the US increase, goods become relatively more expensive than goods from other countries, assuming that price levels stay the same in other countries. → Negative relationship between the price level and net exports.

Define asset price bubble.

Happens when people buy assets for no reason other than that they think the price will go up.

What happens in the short run when there is an increase in AD?

Increase in PRICE AND OUTPUT.

What determines a long run?

NOT A SET AMOUNT OF TIME, It is how long it takes for prices of inputs - such as wages, rent, and raw materials - to fully adjust to changes in the economic condition.

Do the LRAS and SRAS always shift together?

No. Everything that shifts the LRAS shifts the SRAS curve → the available factors of production and technology that determine the position of the LRAS will also drive short-run supply. NOT everything that shifts the SRAS will shift the LRAS curve, changes in expectations about future price levels ONLY affect SRAS. Since for 1. The LRAS is a representation of the production function, located at the economy's potential output. → the ONLY things that can affect the LRAS are the factors that affect how we produce. 2. In the LR expectations are already incorporated into the LRAS curve → NO change.

What happens when we have a NEGATIVE temporary supply shock in the SR & LR?

SR: The SRAS shifts to the LEFT, STAGFLATION → prices will increase, and output will decrease. LR: both prices and output will return to their initial level.

Why is the long aggregate supply cure a vertical line?

Shows that the same amount of output is supplied at any price level.

What is the aggregate supply curve?

Shows the relationship between the overall price level in the economy and total production by firms ( OUTPUT → GDP).

What happens when we have a NEGATIVE PERMANENT supply shock?

The LRAS will shift to the LEFT, the SRAS may not shift immediately, but in the LR, SRAS will continue to to the left until it reaches a new LR equilibrium.

What happens in the long run when there is an increase in AD?

The SRAS has to shift → to restore LR equilibrium → OUTPUT DOESNT CHANGE, BUT BUT PRICES INCREASES.

What does the aggregate supply curve represent?

The aggregate supply curve represents production in the economy as a WHOLE, rather than just one good or service.

Why does the price of oil cause a shift in SRAS instead of a movement along the curve?

The distinction between the two prices. → increase in COST OF INPUT → more costly production.

What gives us the LR equilibrium?

The intersection of the AD, SRAS, and LRAS, at the same point → prices are at expected levels, and the SR level of output = LR level of output.

What gives the short-run equilibrium?

The intersection of the aggregate demand, and SRAS.

What is the main driver of economic growth?

The process of steadily pushing out the longrun aggregate supply curve to the right → increasing potential output.

Define Aggregate Supply.

The sum total of the production of all the firms in the economy.

Define aggregate demand.

The total demand for all goods and services in the economy.

How does the aggregate demand measure the total quantity for goods and services demand in the economy?

Using their market value.

What defines a boom?

When an economy produces above potential output.

What defines a recession?

When an economy produces below potential output.

What is production?

When factor inputs - technology, capital, labour - are combined to produce output.

What can cause the demand curve to shift to the left?

a decrease in consumer and business confidence. - increasing taxes → less money to invest - higher interest rates discourage borrowing - other countries increase their tariffs on US goods, making it more expensive - The dollar strengthens, making US goods more expensive for international consumers.

What is the trade off when the government has to intervene when counteracting negative demand shocks?

between the speed of adjustment and allowing higher prices.

how can a government counteract a negative demand shock?

by increasing government spending, and decreasing taxes → expansionary fiscal policy.

Most wages are automatically increase with inflation, which are some examples that do not increase value with inflation?

cash in your wallet, non-intrest bearing checking accounts, and in other dollar denominated assets. → most people will still experience some reduction in real purchasing power due to these factors regardless of the fact that their wages increased with inflation.

What are some non-price changes that can shift the demand curve?

consumption, government, investment, and Net exports → these shifts the demand curve left or right, making aggregate demand lower or higher at any given price level.

Define deflation.

falling prices

What determines the quantity of output supplied in the long run?

how society's natural resources, labor, and capital can be combined to produce the greatest output. → changes in the long-run aggregate supply curve happen because something changes in the way that society's resources create output.

When does the long run aggregate supply curve shift to the left?

if the economy looses productive capacity.

When does the long run aggregate supply curve shift to the right?

if the potential output of the economy expands.

What is does the aggregate supply curve represent?

potential output → the level of output possible if the economy is operating at full capacity.

What is likely to cause a demand shock?

shocks that affect consumer or government spending.

Government policy is a

short-term policy action that is often applied to address short-term demand shocks.