Chapter 10

Question 1

Long run aggregate supply (definition)

Answer 1

The relationship between the quantity of real GDP supplied and the price level when the money wage rate changes in step with the price level to maintain full employment

Question 2

why is LAS curve vertical?

Answer 2

because potential GDP is independent of the price level

Question 3

Short run aggregate supply (definition)

Answer 3

The relationship between the quantity of real GDP supplied and the price level when the money wage rate, the prices of other resources, and potential GDP remain constant

Question 4

What happens at the price level where the real wage rate is at its full-employment equilibrium level

Answer 4

At this price level, the quantity of real GDP supplied equals potential GDP and the SAS curve intersects the LAS curve

Question 5

Cause of movement along the short-run aggregate supply curve

Answer 5

A change in the price level changes the quantity of real GDP supplied

Question 6

Shift of aggregate supply curve

Answer 6

Aggregate supply changes when an influence on production plans other than the price level changes. These other influences include changes in potential GDP and changes in the money wage rate.

Question 7

Changes in potential GDP and aggregate supply

Answer 7

• When potential GDP changes, aggregate supply changes
• An increase in potential GDP increases both long-run aggregate supply and short-run aggregate supply

Question 8

Why does potential GDP increase

Answer 8

Potential GDP can increase for any of three reasons:
1.) An increase in the full-employment quantity of labour
2.) An increase in the quantity of capital
3.) An advance in technology

Question 9

An Increase in the Full-Employment Quantity of Labour (changes in potential GDP)

Answer 9

Over time, real GDP increases because the labour force increases. But (with constant capital and technology) potential GDP increases only if the full-employment quantity of labour increases. Fluctuations in employment over the business cycle bring fluctuations in real GDP. But these changes in real GDP are fluctuations around potential GDP. They are not changes in potential GDP and long-run aggregate supply.

Question 10

An Increase in the Quantity of Capital (changes in potential GDP)

Answer 10

• For the economy, as the quantity of capital increases, the labour force becomes more productive and potential GDP increases.
• Capital includes human capital

Question 11

An advance in technology (changes in potential GDP)

Answer 11

Technological change enables firms to produce a larger output from any given amount of factors of production. So even with fixed quantities of labour and capital, improvements in technology increase potential GDP.

Question 12

Changes in the money wage rate and aggregate supply

Answer 12

When the money wage rate (or the money price of any other factor of production such as oil) changes, short-run aggregate supply changes but long-run aggregate supply does not change.

Question 13

rise in money wage rate and SAS

Answer 13

A rise in the money wage rate decreases short-run aggregate supply because it increases firms’ costs. With increased costs, the quantity that firms are willing to supply at each price level decreases, which is shown by a leftward shift of the SAS curve.

Question 14

Why rise in money wage rate does not change LAS

Answer 14

A change in the money wage rate does not change long-run aggregate supply because on the LAS curve, the change in the money wage rate is accompanied by an equal percentage change in the price level. With no change in relative prices, firms have no incentive to change production, so real GDP remains constant at potential GDP. With no change in potential GDP, the long-run aggregate supply curve LAS does not shift.

Question 15

What makes money wage rate change

Answer 15

2 reasons
1.) departures from full employment - Unemployment above the natural rate puts downward pressure on the money wage rate, and unemployment below the natural rate puts upward pressure on it
2.) expectations about inflation - An expected rise in the inflation rate makes the money wage rate rise faster, and an expected fall in the inflation rate slows the rate at which the money wage rate rises

Question 16

The quantity of real GDP demanded (Y) formula

Answer 16

Y= C + I + G + X - M

Question 17

The quantity of real GDP demanded definition

Answer 17

the total amount of final goods and services produced in Canada that consumers, businesses, and governments in Canada and around the world plan to buy.

Question 18

Aggregate demand (definition)

Answer 18

the relationship between the quantity of real GDP demanded and the price level

Question 19

why does the aggregate demand curve slope down

Answer 19

The aggregate demand curve slopes downward for two reasons:
1.) Wealth effect
2.) Substitution effects

Question 20

Wealth effect

Answer 20

• When the price level rises and other things remain the same, real wealth decreases
• Real wealth is the amount of money in the bank, bonds, shares, and other assets that people own, measured not in dollars but in terms of the goods and services that the money, bonds, and shares will buy
• People save and hold money, bonds, and shares for many reasons (r.g education or retirement)
• If the price level rises, real wealth decreases
• People then try to restore their wealth. To do so, they must increase saving and, equivalently, decrease current consumption expenditure
• As the price level rises, the decrease in consumption expenditure decreases the quantity of real GDP demanded

Question 21

Substitution effects (Intertemporal)

Answer 21

• involves changing the timing of purchases of capital and consumer durable goods
• faced with a higher interest rate, people and businesses delay plans to buy new capital and consumer durable goods and cut back on spending today
• faced with a higher interest rate, people and businesses delay plans to buy new capital and consumer durable goods and cut back on spending today

Question 22

substitution effects (International prices)

Answer 22

• When the Canadian price level rises and other things remain the same, Canadian-made goods and services become more expensive relative to foreign-made goods and services
• This change in relative prices encourages people to spend less on Canadian-made goods and more on foreign-made goods.

Question 23

Changes in the Quantity of Real GDP Demanded

Answer 23

• When the price level rises and other things remain the same, the quantity of real GDP demanded decreases - a movement up along the AD curve
• When the price level falls and other things remain the same, the quantity of real GDP demanded increases—a movement down along the AD curve

Question 24

Main factors that change aggreagate demand

Answer 24

1.) Expectations
2.) Fiscal policy
3.) Monetary policy
4.) The world economy

Question 25

expectations (aggregate demand)

Answer 25

An increase in expected future income increases the amount of consumption goods (especially expensive items such as cars) that people plan to buy today and increases aggregate demand today.

Question 26

Fiscal Policy

Answer 26

the use of the fedral budget by setting and changing tax rates, making transfer payments and purchasing goods and services to achive macroeconomic objecties such as full employment, sustained econ growth and price level stability

Question 27

Disposable income

Answer 27

aggregate income minus taxes plus transfer payments.

Question 28

Monetary policy

Answer 28

The Bank of Canada’s attempt to influence the economy by changing interest rates and the quantity of money

Question 29

short run macro econ equillbrium

Answer 29

occurs when the quantity of real GDP demanded equals the quantity of real GDP supplied

Question 30

Long run macro equillbrium

Answer 30

occurs when real GDP equals potential GDP—equivalently, when the economy is on its LAS curve.

Question 31

Economic Growth and Inflation in the AS-AD Model

Answer 31

Economic growth results from population growth and labour productivity growth, which together make potential GDP grow (Chapter 6). Inflation results from a growing quantity of money that outpaces the growth of potential GDP (Chapter 8).