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Macroeconomics SEM 2 > AD-AS > Flashcards

AD-AS Flashcards

1
Q

Why can Business Cycles be bad for an Economy?

A

Recessions–> Unemployment

Booms–> Inflation + Bubbles (potentially)

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2
Q

What is a Recession?

A
  • Economic Contraction
  • Period of Decreased Real Incomes + Increased Unemployment
    2 Consecutive Quarters of Negative Real GDP Growth
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3
Q

What is a Depression?

A

Severe Recession

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4
Q

What are the 3 main Facts about Economic Fluctuations?

A
  1. Economic Fluctuations are Irregular + Unpredictable
  2. Most Macroeconomic quantities fluctuate together
  3. As Output falls–> Unemployment Rises
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5
Q

What are the 2 main building blocks of Classical Economic Theory for SR Fluctuations?

A

Classical Dichotomy

Monetary Neutrality

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6
Q

What is Classical Dichotomy?

A

Separating Nominal + Real Variables

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7
Q

What is Monetary Neutrality?

A

Changes in M.S affect Nominal but NOT Real variables

- Can examine determinants of Real Variables without reference to Nominal variables

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8
Q

According to Classical Economic Theory, what happens in SR?

A

Assumption of Monetary Neutrality- No longer appropriate
- Real + Nominal variables are intertwined
- Changes in M.S- can temporarily push Real GDP away from its LR trend
THEREFORE- Need a NEW SR Model

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9
Q

What is Controversial about Real Business Cycle Theory?

A

Business Cycles occur Naturally- NOT due to Sticky Prices

- Trying to remove Cycles- Distort Market Mechanism- worsen situation

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10
Q

What does the AD-AS model show?

A

Explains SR fluctuations in Economic activity around LR trend
- Focusses on relationship between Prices + Real GDP

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11
Q

What does AD show?

A

Quantity of G+S Households, Firms, Gov. + Customers Abroad want to Buy at each Price Level

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12
Q

What is the Price Level?

A

Aggregate Price Index- e.g. GDP Deflator, CPI etc.

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13
Q

What 3 things explain why AD is Downward Sloping?

A
  • Wealth Effect - C
  • Interest-rate Effect - I
  • Exchange Rate Effect - NX
    Assume G is a Fixed Policy
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14
Q

What is the Wealth Effect?

A

Decreased Price Level –> Increased Value of Money –> Consumer feels Wealthier + Increases C –> Increased AD

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15
Q

What is the Interest-rate Effect?

A

Decreased Price Level –> Need to hold less Money–> Reduced M.D –> Increases Private Savings–> Increased S of Loanable Funds–> Decreased I.R –> Increased I–> Increased AD

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16
Q

What is the Exchange Rate Effect?

A

Fall in UK Price Level –> Decreased I.R–> Increased NCO + S of £ on FX Market–> Fall in £ ER–> Increased X + Decreased M–> Increased NX–> Increased AD

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17
Q

If Price Levels Increase, what happens to C, I + NX?

A
  1. Consumers Poorer- Decreased C
  2. Increased I.R- Decreased I
  3. Increased £ ER- Decreased NX
    Decreased Qd for G+S
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18
Q

What is the relationship between P and QD for G+S?

A

NEGATIVE- AD Downward Sloping

19
Q

What can cause AD to Shift?

A

Changes in C, I, G + NX

20
Q

What changes in C can Shift AD?

A

Events that change how much people want to consume at a Given Price Level
- e.g. Change in Taxes, Wealth…

21
Q

What changes in I can Shift AD?

A

Events that change how much firms want to invest at a Given Price Level
- e.g. Better Technology, Changes in Taxes or M.S

22
Q

What changes in G can Shift AD?

A

Policy makers can change G at a Given Price Level

- e.g. Build new roads

23
Q

What changes in NX can Shift AD?

A

Events that change NX for a Given Price Level

- e.g. Recession in Trading Partners

24
Q

What does AS show?

A

Quantity of G+S firms Produce + Sell at a Given Price Level

25
Q

What is LRAS?

A

Price Level does NOT affect LR determinants of GDP

  • Supplies of Labour, Capital, Natural Resources + Technology matter for LRAS
  • Classical Dichotomy + Monetary Neutrality hold
26
Q

Where is LRAS Vertical?

A

At Natural Rate of Output

- Production of G+S in LR when Unemployment at NRU

27
Q

What causes a Shift in LRAS?

A
  • Changes in Labour- immigration, births, policy to change Frictional + Structural Unemployment
  • Changes in Capital- affects Productivity
  • Changes in Natural Resources
  • Changes in Technology + Technological Knowledge
28
Q

What can shift in LR?

A

Both AD + LRAS

29
Q

What does Technological Progress lead to?

A

Continual Shift of LRAS to Right

30
Q

In LR- what type of Policy shifts AD to Right?

A

Monetary Policy

31
Q

What is the Result of AD + LRAS shifting to the Right?

A

Continuing Growth in Output

- Continuing Inflation

32
Q

In SR- how are Price Level + Qs of G+S related?

A
  • Increased Price Level–> Increased Prices + Profitability–> Increased Qs of G+S
  • Decreased Price Level–> Decreased Prices + Profitability–> Decreased Qs of G+S
33
Q

What 3 things explain why SRAS is Upward Sloping?

A
  • Sticky-Wage Theory
  • Sticky-Price Theory
  • Misperceptions Theory
    Cause Output to deviate from Natural Level due to Actual P ≠ Expected P
34
Q

What happens if P rises above Expected Level?

A

Output Increases ABOVE Natural Rate

35
Q

What is Sticky-Wage Theory?

A
  • Nominal Wages- Slow to adjust to changing Econ. conditions- due to fact Labour contracts are fixed in Medium Term
  • Nominal Wages- based on Expected Prices- Do NOT respond immediately when Actual deviates from Expected
36
Q

Under Sticky-Wage Theory, what happens if Price Level < Expected Level?

A

Firms- Incentive to Reduce Output- Wages/Prices Higher than expected
–> Increased CoPs–> Hire less workers

37
Q

Under Sticky-Wage Theory, what happens if Price Level > Expected Level?

A

Firms- Incentive to Increase Output- Wages/Prices Lower than expected
–> Decreased CoPs–> Hire more workers

38
Q

What is Sticky-Price Theory?

A

Prices of some G+S: - Slow to Adjust + Menu Costs

39
Q

Under Sticky-Price Theory, what happens if Price Level < Expected Level?

A

Some Firms have Higher Prices than desired –> Decreased Sales + Decreased Output

40
Q

What is Misperceptions Theory?

A

Changes in Overall Price Level- can temporarily mislead supplier about changes in Individual Markets

  • Mistakenly Infer changes in absolute Prices as a change in Relative Prices
  • Suppliers respond to changes in level of Prices–> Changes in Qs of G+S
41
Q

Under Misperceptions Theory, what happens if Price Level < Expected Level?

A

Some suppliers might think this represents Reduced Relative Demand for their Product–> Reduced Output

42
Q

How is Qs calculated?

A

Qs = NRO + a( Actual PL - Expected PL )

where a determines how much output responds to Unexpected changes in PL

43
Q

What happens to SRAS in LR + why?

A

In LR- Actual Prices = Expected Prices

–> SRAS = LRAS

44
Q

What causes a Shift in SRAS?

A

Changes in: Labour, Capital, Natural Resources, Technological Knowledge
- Expected Price Increases–> SRAS LEFT Shift

Macroeconomics SEM 2 (13 decks)

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