Chapter 13

Short run aggregate supply

- Upward sloping aggregate supply curve -Input costs are slow to change in the short run -Profits rise with increased output

In monetary policy -more money ____ AD -less money ____ AD

- increase -decrease

Recessionary gap dynamics

-A surplus of labor. Meaning too much unemployment exists. Maybe 8-9%. -Firms hire new workers at lower wage rate. -As money wage rate falls, AS shifts from AS1 to AS2. -Price level falls and real GDP increases. Yp - Ya = Recessionary Gap

If price level is below equilibrium level...

-Aggregate quantity demanded is greater than aggregate quantity supplied - Firms inventories decline -Firms respond by increasing both production and prices - Higher price level reduces aggregate quantity demanded -Process continues until equilibrium reached

If price level is above equilibrium level...

-Aggregate quantity supplied is greater than aggregate quantity demanded -Firms inventories increase -Firms respond by decreasing production and price --Lower price level increase aggregate quantity demanded -Process continues till equilibrium reached

Characteristics of full employment equilibrium

-An economy will stay there unless there are changes in behavior of suppliers, households, firms, governments or foreign sector. -If economy is not there, forces of AD and AS will cause economy to move to equilibrium -Once there, no incentive to change behavior -May not be optimal economic conditions

Why does Aggregate demand curve slope down

-Buying (purchasing power) of money (wealth effect) -Real interest rate -Real prices of exports and imports -Rise in price level decreases buying power of money, raises real interest rate, raises real price of domestic goods compared with foreign goods, decreases quantity real GDP demanded.

Real interest rate

-Change in price level can affect interest rate and affect quantity of investment demanded -Lower price level reduces quantity of money demanded, increases household savings -Lower interest rate since more money is available in loanable funds market -Encourage spending on investment -Aggregate demand increases when investment increases -Aggregate demand decreases when investment decreases

Factors that change aggregate demand and shift AD curve are...

-Expectations about future -Fiscal (taxing/spending at federal level) and monetary policy -State of world economy

Inflationary Gap

-Gap exists when real GDP exceeds potential GDP and brings rising price level. There is a shortage of labor and firms must offer higher wage rate to hire labor they demand.

Recessionary Gap

-Gap that exists when potential GDP exceeds real GDP and brings a falling price level. There is a surplus of labor and firms can hire new workers at lower wage rate.

Changes in what factors will shift the aggregate supply curve

-Potential GDP -Money (nominal) wage rate -Money (nominal) prices of resources (inputs)

Inflationary Gap dynamics

-Shortage of labor. Too little unemployment. Remember unemployment needs to be around 4-5% -To hire new workers firms raise wage rate. -As money wage rate rises, AS shifts from AS2 to AS*. -Price level rises and real GDP falls. Ya-Yp = Inflationary Gap

Buying power of money

-Tendency for change in price level to affect buying (purchasing) power and alter consumption -Lower price level increases buying power -Higher price level decreases buying power -Higher buying power encourages higher consumption spending -Lower buying power encourages lower consumption spending -When C increases, aggregate demand increases -When C decreases, aggregate demand decreases - increase in C = increase in Real GDP - decrease in C= decrease in Real GDP

Long run equilibrium is optimal in that

-There is no over or under production in economy -Economy producing all output it is capable of producing at potential output -Full employment -No upward or downward pressure on price level -All participants in economy obtained enough info to adjust behavior

Long run aggregate supply

-Vertical aggregate supply curve - Economy is at potential full employment output level -All variables have time to adjust to costs

Describe graph on other side

A rise in money wage rate causes price level to increase and decreases aggregate supply. The aggregate supply curve shifts leftward from AS0 to AS2. A rise in money wage rate does not change potential GDP.

Non intervention policy

Allows economy to adjust on own, AS curve shifts

Describe graph on other side

An increase in potential GDP increases aggregate supply. When potential GDP increases from 16 trillion to 17 trillion, the aggregate supply curve shifts rightward from AS0 to AS1.

flip and review

As price falls, quantity demanded increases, and quantity supplied decreases As price rises, quantity demanded decreases, quantity supplied rises. If more demanded, increase price and increase production to get to equilibrium If less demanded, decrease price, and decrease production to get to equilibrium

How is the relationship between price level and total spending shown

By the downward sloping aggregate demand curve

monetary policy

Changing quantity of money and interest rate

Fiscal policy

Consumption and Government

Macroeconomic equilibrium

Occurs when quantity of Real GDP demanded equals quantity of real GDP supplied. No net pressures for economy to expand or contract.

Expansionary policy

Policy designed to increase real gdp, shift in AD

Contractionary policy

Policy designed to reduce real GDP, shift in AD

Aggregate Supply -Define -Describe relationship

Real GDP that firms will produce at varying price levels. Other things remaining the same, the higher the price level, the greater the quantity of real GDP supplied, and the lower the price level, the smaller is the quantity of real GDP supplied.

What should be kept in mind when determining aggregate supply?

Short run aggregate supply Long run aggregate supply

Aggregate Demand

The relationship between total quantity of real GDP demanded and price level, with all other determinants of spending unchanged.

Monetary policy

Use of central bank policy to influence level of economic activity, Shift in AD

Fiscal policy

Use of government purchases, transfer payments, and taxes to influence level of economic activity, shift in AD

Full employment equilibrium

When equilibrium real GDP equals potential GDP. Occurs when AD curve intersects AS curve.

Why does aggregate supply curve shift upward

With given money wage rate, rise in price level lowers real wage rate, increases quantity of labor demanded, increases quantity of real GDP supplied.

Aggregate supply refers to...

behavior of producers in face of given set of prices

Major determinant of total spending in economy

overall price level

Aggregate demand refers to...

relationship between decisions made by all households, firms, governments, and foreign sector when facing given prices