aggregate demand and supply

Question 1

What is aggregate supply?

Answer 1

total quantity of goods and services produced in an economy (real GDP) over a particular period of time at different price levels

Question 2

What is the short-run aggregate supply curve?

Answer 2

shows the relationship between price levels and quantity of real output (real GDP) produced by firms when resource prices don’t change

Question 3

What is the short-run?

Answer 3

period of time where the resources (wages) are fixed and don’t adjust with price levels

Question 4

What is the long-run?

Answer 4

period of time where resources (wages) are variable and can adjust with changes in price levels

Question 5

What are the reasons for wage rigidity?

Answer 5

• fixed wage contracts
• minimum wage legislation
• trade unions
• wage cuts demotivate workers and lower productivity

Question 6

What causes SRAS to shift to the left?

Answer 6

• wages increase
• resources prices rise
• indirect taxes increase
• subsidies are removed
• supply shocks

Question 7

What causes SRAS to shift to the right?

Answer 7

• wages decrease
• resources prices decline
• indirect taxes cut
• subsidies given
• supply shocks

Question 8

What is the AD-AS equilibrium?

Answer 8

where AD intersects AS

Question 9

What is the short-run AD-AS equilibrium?

Answer 9

points of intersection between AD and SRAS and determines the price levels

Question 10

What is the price-wage spiral?

Answer 10

increasing wages shifts the SRAS to the left, resulting in higher prices, which calls for more increase in wages

Question 11

What is aggregate demand?

Answer 11

total amount of real output (real GDP) that consumers, firms, the government and foreigners want to buy at each possible price level

Question 12

What is the aggregate demand supply curve?

Answer 12

AD curve shows the relationship between the total output demanded and the economy’s price level over a period of time

Question 13

What are the causes of changes in consumption?

Answer 13

• change in consumer confidence
• change in interest rates
• changes in wealth
• changes in income tax
• changes in levels of household indebtedness
• expectations of future price levels

Question 14

What are the causes of changes in investment spending?

Answer 14

• change in consumer confidence
• change in interest rates
• improvements in technology
• changes in business taxes
• level of corporate indebtedness
• legal or institutional changes

Question 15

What are the causes of changes in government spending?

Answer 15

• changes in political priorities
• changes in economic priorities

Question 16

What are the causes of changes in net exports?

Answer 16

• changes in national income abroad
• changes in exchange rates
• changes in trade policies

Question 17

What is the monetarist approach to LRAS?

Answer 17

LRAS curve is vertical at full employment level, so in the long-run, changes in AD only change price levels, not GDP

Question 18

What is LRAS?

Answer 18

Long-run aggregate supply - relationship between price level and aggregate output

Question 19

When is there a long-run equilibrium?

Answer 19

When the SRAS and AD curve intersect the LRAS curve at full level of employment

Question 20

Why is LRAS vertical?

Answer 20

LRAS is vertical because price of resources are flexible and change to match output, so costs stay the same

Question 21

What is full employment?

Answer 21

when an economy produces at maximum potential output and all resources are being utilized

Question 22

How is real GDP and potential GDP shown?

Answer 22

Real GDP = where SRAS meets AD
Potential GDP = where LRAS meets AD

Question 23

What is an inflationary/deflationary gap?

Answer 23

Inflationary gap = actual output > potential output (+)
Deflationary gap = actual output < potential output (-)

Question 24

How does a deflationary gap occur?

Answer 24

• AD shifts to the left
• gap in total output is to the left of LRAS
• greater rate of unemployment than natural rate due to insufficient AD

Question 25

How does an inflationary gap occur?

Answer 25

• AD shifts right
• gap in output is to the right of LRAS
• smaller rate of unemployment than natural rate

Question 26

What is stagflation?

Question 27

Why can’t output gaps persist in the long-run?

Answer 27

• eliminated in the long-run as the economy has built in tendency towards full employment
• changes in AD only impact in the short-run and in the long run, only price levels change, not real GDP

Question 28

What does the shape of the Keynesian Graph mean?

Answer 28

Horizontal - changes in AD doesn’t affect APL
SLoping - increased APL with AD
Vertical - resources are used fully

Question 29

What are Keynesian views on sticky wages?

Answer 29

economy cannot move in the long-run when experiencing a deflationary gap

Question 30

What are differences between Keynesian and New Classical models?

Answer 30

1) output gaps
Keynesian - output gaps can persist in the long-run due to insufficient AD
New Classical - economy self-corrects and will return to full employment level
2) APL
Keynesian - changes in AD doesn’t affect the price levels (horizontal part)
New Classical - increase in AD leads to higher price levels