Ch. 12- Aggregate Demand and Aggregate Supply

Question 1

Aggregate Demand

Answer 1

The total demand for all goods and services in the economy

Question 2

Aggregate Demand Curve (AD curve)

Answer 2

A curve that shows the relationship between the overall price level and the level of demand in the economy. Slopes downward.

Question 3

Why does the aggregate demand curve slope downwards?

Answer 3

> The Wealth Effect
The Interest Rate Effect
The Exchange Rate Effect

Question 4

Wealth Effect

Answer 4

When people are less wealthy or prices rise, they reduce their consumption

Question 5

Interest Rate Effect

Answer 5

When prices increase, interest rates increase. Therefore, firms invest less since it is more expensive for them to borrow

Question 6

Exchange Rate Effect

Answer 6

When prices of domestic goods increase, imports increase, exports decrease. Therefore, net exports decrease and GDP decreases

Question 7

What causes the aggregate demand curve to shift?

Answer 7

Non-price changes in consumption, investment, government spending, or net exports.

Question 8

Asset-price bubble

Answer 8

When people buy assets for no reason other than thinking that the price will increase

Question 9

What effect does the multiplier effect have on shifts in aggregate demand?

Answer 9

Each dollar of expenditure in the economy leads to more than a dollar of output.

Question 10

Aggregate Supply

Answer 10

The sum total of the production of all the firms in the economy

Question 11

Aggregate Supply Curve (AS curve)

Answer 11

Shows the relationship between the overall price level in the economy and total production (output)

Question 12

What are the differences between the AS curve and the supply curve in microeconomics?

Answer 12

> AS represents production in the economy as a whole rather than just one good or service

> AS represents that there is a difference between how the economy operates in the short-run vs the long-run

Question 13

Sticky Wages

Answer 13

Not all input prices increase immediately as they adjust slowly in response to changes in the economy.

Question 14

Why is the SRAS curve upward sloping?

Answer 14

Due to sticky wages, firms have an incentive to increase production when the prices of their output are rising (input costs will remain fixed).

Question 15

Short-run Aggregate Supply Curve (SRAS curve)

Answer 15

Short-run relationship between prices and output. Changes in the price level and non-price changes affect the economy’s output (and shift the SRAS).

Question 16

Long-Run Aggregate Supply Curve (LRAS curve)

Answer 16

Long-run relationship between prices and output. Only non-price changes can shift the LRAS curve

Question 17

Why is the LRAS curve vertical?

Answer 17

A change in price level does not affect output since in the long-run, input prices will adjust. So while revenues may be higher, costs are also higher.

Question 18

What time period is the long-run defined as?

Answer 18

The long-run is not a set amount of time. It is however long it takes for prices of inputs to fully adjust to changes in economic conditions.

Question 19

Business Cycles

Answer 19

Fluctuations of GDP either above or below the potential level of GDP in the economy.

Question 20

Supply Shocks

Answer 20

Significant events that directly affect production and the aggregate-supply curve in the short-run

Question 21

Short-run equilibrium

Answer 21

Given by the intersection of the aggregate demand and SRAS curves

Question 22

Long-run equilibrium

Answer 22

Given by the intersection between the aggregate demand, SRAS, and LRAS curves (same point).

Question 23

Why do business cycles occur?

Answer 23

> Instability of AD - significant expansions and contraction in the components of AD.
Supply shocks

Question 24

How does the economy return to the long-run equilibrium?

Answer 24

Contracts must be negotiated to adjust wages. This causes the SRAS to gradually shift until equilibrium is restored.

Question 25

What are the effects of a shift in AD?

Answer 25

> Short-run: There are fluctuations in the economy’s output of goods and services.

> Long-run: Affects the overall price level but do not affect the level of output

> Policymakers who intervene can potentially mitigate the severity of business cycles

Question 26

What are the effects of a shift in AS?

Answer 26

> Stagflation
Policymakers who intervene can potentially mitigate the adverse impact on output but at the cost of increasing price level.

Question 27

Stagflation

Answer 27

A period of decreasing output and increasing prices.

Question 28

Why is it desirable for government to intervene when the economy undergoes supply/demand shocks?

Answer 28

It can take a long time for the economy to fully adjust to aggregate demand/supply shocks on its own.

Question 29

How can governments respond to supply and demand shocks?

Answer 29

By adjusting spending to shift the AD/AS curve towards long-term equilibrium.