Chapter 11

Say the government changes the design of currency, and it's so beautiful that holding money is more appealing to the public. What happens to the demand for money? What happens to the velocity of money?

Demand for money will increase Velocity of money will decrease

When does the classical dichotomy NOT hold?

When not all prices are flexible

If the Fed accommodates an adverse supply shock, output falls _____, and prices rise _____.

less, more

The Fed might _______ the money supply to offset the increase in velocity

reduce

long run growth in GDP largely determined by _____; short-run growth in GDP largely determined by ______

technological progress; utilization of labor force

What was unusual about Covid-19's effect on the economy?

the economy's natural level of output fell (long run aggregate supply fell)

Government economists forecast short-run economic fluctuations because:

the state of the economy affects the government directly by influencing, among other things, how much tax revenue it collects and forecasts are an input into policy planning

What is the expected result of a decrease in the velocity of money in the long run?

The price level will fall and output will not change.

From a macroeconomic theory perspective, what is unusual about the Covid-19 recession?

There was a shift in the economy's potential output.

Suppose that there is a sudden decrease in oil prices. What happens in the AD-AS model? Say the Fed wanted to keep the output (and unemployment) levels stable. What action would they take? What effect would that have in the AD-AS model?

Shifts SRAS down (favorable supply shock) Firms have lower production/transportation costs, can lower prices The Fed could Decrease the money supply which shifts AD to the left (accommodating the shock) Keeps Y at its natural level, lowers P

How does the economy move from a short-run equilibrium to its long-run equilibrium?

Shifts occur in the short-run aggregate supply curve.

Say the government changes the design of currency, and it's so beautiful that holding money is more appealing to the public. What happens to price level in short run and long run?

Because velocity decreases, aggregate demand shifts left. In the short run, the price stays constant (sticky prices), and output decreases. In the long run, prices adjust downward, and output goes back to its original level.

What is a valid description of the aggregate demand curve?

It tells us the possible combinations of the price level and output for a given money supply.

Why do the short-run and long-run aggregate supply curves have different slopes?

Sticky Prices

the increase in velocity causes

aggregate demand to increase

Classical dichotomy and monetary neutrality describe how the economy works in the --

long run

Faced with an adverse supply shock, policymakers at the Fed with the ability to influence aggregate demand have a hard choice between two options.

1. hold aggregate demand constant. In this case, output and employment are lower than the natural level. Eventually, prices will fall to restore full employment at the old price level, but the cost of this adjustment process is a painful recession. 2. expand aggregate demand to bring the economy toward the natural level of output more quickly. drawback is that price level is permanently higher

For macroeconomists, what distinguishes the short run and the long run?

Whether prices are sticky or flexible

What criterion does the NBER's Business Cycle Dating Committee use to determine when the economy goes into recession?

A variety of data and its professional judgement

Stagflation—lower output and higher prices—is caused by

an adverse shock to aggregate supply.

Reduction in the money supply is equivalent to ---

an increase in the velocity of money (k falls, 1/k rises)

If Central Bank A cares only about keeping the price level stable and Central Bank B cares only about keeping output at its natural level, then in response to an exogenous decrease in the velocity of money:

both Central Bank A and Central Bank B should increase the quantity of money.

If the Fed reduces the money supply, aggregate demand will _____ If the Fed increases the money supply, aggregate demand will _____

fall rise

In a typical recession, consumption ____________. Investment moves in the same direction but proportionately ____________.

falls, more

Over long periods of time, prices are _______, the aggregate supply curve is _______, and changes in aggregate demand affect the ______ but not ________. Over short periods of time, prices are ______, the aggregate supply curve is ______, and changes in aggregate demand affect the economy's _______

flexible, vertical, price level, output sticky, flat, output

For a fixed money supply, the aggregate demand curve slopes downward because at a lower price level, real money balances are _____, generating a _____ quantity of output demanded

higher, greater

If the short-run aggregate supply curve is horizontal, an increase in union aggressiveness that pushes wages and prices up will result in _____ prices and _____ output in the short run.

higher, lower

According to the text, in a country where the central bank has a mandate to maintain full-employment output, the BEST reaction to a negative demand shock that decreases output below the natural level would be to:

increase the money supply

In a hypothetical country, a central bank has a mandate to maintain full-employment output. Unfortunately, a drought destroys crops and drives up food prices, leading to a higher overall price level. According to the text, the BEST action that this central bank can take is to stabilize output by:

increasing the money supply but accepting a permanently higher price level.

In the short run, many prices do not respond to changes in---

monetary policy

Changes in aggregate demand will affect _______ in the short run aggregate supply curve

output

If the aggregate long run supply curve is vertical, then changes in aggregate demand affect _____ but not ______

prices, output