Econ Final Exam Cpt 20

What happens to the price level and real output in the short run?

Prices rise, and output falls.

short-run aggregate supply shifts left

Prices rise; output falls. Price level returns to original value; output returns to the natural level. Shift aggregate demand to the right.

aggregate demand shifts right

Prices rise; output rises. Prices rise; output returns to the natural level. Shift aggregate demand to the left.

If policymakers were able to move output back to the natural level of output, what would the policy do to prices?

Prices would rise more and remain there.

If policymakers wanted to move output back to the natural level of output, what should they do?

Shift aggregate demand to the right.

short-run aggregate supply shifts right

Prices fall; output rises. Price level returns to original value; output returns to the natural level. Shift aggregate demand to the left.

Suppose the economy is in long-run equilibrium. Then, suppose the Federal Reserve suddenly increases the money supply. Describe the initial impact of this event in the model of aggregate demand and aggregate supply by explaining which curve shifts which way.

Aggregate demand shifts to the right.

Suppose the economy is at a point such as point B in Exhibit 2. That is, aggregate demand has decreased, and the economy is in a recession. Describe the adjustment process necessary for the economy to adjust on its own to point C for each of the three theoretical short-run aggregate-supply curves. the sticky-wage theory

At point B, prices have fallen, but nominal wages are stuck at a high level based on a higher price expectation. Firms are less profitable, and they cut back on production. As workers and firms recognize the fall in the price level (learn to expect ), new contracts will have a lower nominal wage. The reduction in labor costs causes firms to increase production at each price level shifting the short-run aggregate supply to the right.

the sticky-price theory

At point B, some firms have not reduced their prices because of menu costs. Their products are relatively more expensive, and sales fall. When they realize the lower price level is permanent (learn to expect ), they lower their prices and output rises at each price level, shifting the short-run aggregate supply to the right.

the misperceptions theory

At point B, some firms mistakenly believe that only the price of their product has fallen and they have cut back on production. As they realize that all prices are falling (learn to expect ), they will increase production at each price, which will shift short-run aggregate supply to the right.

Why is a decrease in the money supply unlikely to be neutral in the short run?

Because a decrease in aggregate demand from a decrease in the money supply may reduce the price level unexpectedly. In the short run, some prices and wages are stuck, and some producers have misperceptions regarding relative prices causing output to fall.

If the economy is in a recession, why might policymakers choose to adjust aggregate demand to eliminate the recession rather than let the economy adjust, or self-correct, on its own?

Because they think they can get the economy back to the long-run natural level of output more quickly or, in the case of a negative supply shock, because they are more concerned with output than inflation.

What causes both short-run and long-run aggregate supply to shift together? What causes only the short-run aggregate supply to shift while the long-run aggregate supply remains stationary?

Changes in the available factors (labor, capital, natural resources) and technology shift both long-run and short-run aggregate supply. Changes in price expectations that may be associated with wage demands and oil prices only shift short-run aggregate supply.

Name the three key facts about economic fluctuations.

Economic fluctuations are irregular and unpredictable; most macroeconomic quantities fluctuate together; and when output falls, unemployment rises.

Explain the slope of the short-run aggregate-supply curve using the sticky-wage theory.

In the short run, nominal wages are fixed based on fixed-price expectations. If actual prices unexpectedly fall while nominal wages remain fixed, firms are less profitable, and they cut back on production.

Which component of aggregate demand is most volatile over the business cycle?

Investment.

Do you think the type of adjustments would take place more quickly from a recession or from a period when output was above the long-run natural level? Why or why not?

More slowly from a recession because it requires prices to be reduced, and prices are usually more sticky downward. The adjustment when output is above normal requires prices and wages to rise.

Does a shift in aggregate demand alter output in the long run? Why or why not?

No. In the long run, output is determined by factor supplies and technology (long-run aggregate supply). Changes in aggregate demand only affect prices in the long run.

Is it likely that an increase in price expectations and wages alone can cause a permanent increase in the price level? Why or why not?

No. Increases in the cost of production need to be "accommodated" by government policy to permanently raise prices.

Does an increase in the money supply move output above the natural level indefinitely? Why or why not?

No. Over time, people and firms adjust to the new higher amount of spending by raising their prices and wages.

What happens to prices and output in the short run? What happens to prices and output in the long run if the economy is allowed to adjust to long-run equilibrium on its own? If policymakers had intervened to move output back to the natural level instead of allowing the economy to self-correct, in which direction should they have moved aggregate demand? aggregate demand shifts left

Prices fall; output falls. Prices fall; output returns to the natural level. Shift aggregate demand to the right.

What happens to the price level and real output in the short run?

Price level rises, and real output rises.

If the economy is allowed to adjust to the increase in the money supply, what happens to the price level and real output in the long run when compared to their original levels? What name do economists attach to the long-run impact of a change in the money supply on the economy?

Price level rises, and real output stays the same. Money neutrality.

Suppose the economy is in long-run equilibrium. Then, suppose workers and firms suddenly expect higher prices in the future and agree to an increase in wages. Describe the initial impact of this event in the model of aggregate demand and aggregate supply by explaining which curve shifts which way.

Short-run aggregate supply shifts left.

Suppose OPEC breaks apart and oil prices fall substantially. Initially, which curve shifts in the aggregate-supply and aggregate-demand model? In what direction does it shift? What happens to the price level and real output?

Short-run aggregate supply shifts right. Prices fall, and output rises.

What name do we have for this combination of movements in output and prices?

Stagflation.

If policymakers had done nothing at all, what would have happened to the wage rate as the economy self-corrected or adjusted back to the natural level of output on its own?

The high unemployment at the low level of output would put pressure on the wage to fall back to its original value shifting short-run aggregate supply back to its original position.

What are the three reasons the aggregate-demand curve slopes downward? Explain them.

Wealth effect: Lower prices increase the value of money holdings and consumer spending increases. Interest-rate effect: Lower prices reduce the quantity of money held, some is loaned, interest rates fall, and investment spending increases. Exchange-rate effect: Lower prices decrease interest rates, the dollar depreciates, and net exports increase.

Does a shift in aggregate demand alter output in the short run? Why or why not?

Yes. Changes in aggregate demand cause actual prices to deviate from expected prices. Due to sticky wages, sticky prices, and misperceptions about relative prices, firms respond by changing output.

The Federal Reserve decreases the money supply.

aggregate demand, left

Americans feel more secure in their jobs and become more optimistic.

aggregate demand, right

The following events have their initial impact on which of the following: aggregate demand, short-run aggregate supply, long-run aggregate supply, or both short-run and long-run aggregate supply? Do the curves shift to the right or left? The government repairs aging roads and bridges.

aggregate demand, right

The government increases the minimum wage.

both short-run and long-run aggregate supply, left

The government raises unemployment benefits, which raises the natural rate of unemployment.

both short-run and long-run aggregate supply, left

A technological advance takes place in the application of computers to the manufacturing of steel.

both short-run and long-run aggregate supply, right

A drought destroys much of the Midwest corn crop.

short-run aggregate supply, left

OPEC raises oil prices.

short-run aggregate supply, left

Because price expectations are reduced, wage demands of new college graduates fall.

short-run aggregate supply, right