Chapter 13

Fiscal policy

-Changes in federal taxes ad purchases that are intended to achieve macroeconomic policy objectives Because government purchases are one component of aggregate demand:' -An increase in government purchases shifts the aggregate demand curve to the right, and a decrease in government purchases shifts the aggregate demand curve to the left. -An increase in personal income taxes reduces households' disposable income, which reduces consumption spending and shifts the aggregate demand curve to the left. A decrease in personal income taxes shifts the aggregate demand curve to the right. -An increase in business taxes reduces the profitability of investment spending and shifts the aggregate demand curve to the left. A decrease in business taxes shifts the aggregate demand curve to the right.

Firms supply more goods and services as the price level increases for two key reasons:

1) As prices of final goods and services rise, prices of inputs—such as the wages of workers or the price of natural resources—rise more slowly. Profits rise when the prices of goods and services firms sell rise more rapidly than the prices they pay for inputs. Therefore, a higher price level leads to higher profits and increases the willingness of firms to supply more goods and services. 2) As the price level rises, some firms are slow to adjust their prices. A firm that is slow to raise its prices when the price level is increasing may find its sales increasing and, therefore, will increase production.

variables that cause the aggregate demand curve to shift fall into three categories:

1) Changes in government policies 2)Changes in the expectations of households and firms 3)Changes in foreign variables

Economists are not in complete agreement on this point, but we can briefly discuss the three most common explanations:

1) Contracts make some wages and prices "sticky." 2) Firms are often slow to adjust wages. 3) Menu costs make some prices sticky.

Aggregate Demand (AD) curve

A curve that shows the relationship between the price level and the quantity of real GDP demanded by households, firms, and the government (both inside and outside of the country)

Long-run aggregate suplly (LRAS) curve

A curve that shows the relationship in the long run between the price leve and the quality of real GDP supplied

Short-run aggregate supply (SRAS) curve

A curve that shows the relationship in the short run between the price level and the quantity of the real GDP supplied by firms

Aggregate demand and Aggregate supply model

A model that explains short run fluctuations in real GDP and the price level

Supply Shock

An unexpected event that causes the short-run aggregate supply curve to shift

Monetary Policy

The actions the Federal Reserve takes to manage supply and interest rates to achieve macroeconomic policy objectives

Menu cost

The costs to firm of changing prices