Aggregate Supply

Question 1

Macroeconomic Goals

Answer 1

Goals - Framework - Policy Tools

Question 2

Economic Growth (approximated by GDP growth)

Answer 2

Determines the prevailing standard of living in a country

Question 3

Unemployment

Answer 3

Loss of potential value in output for the whole of society

Question 4

Inflation

Answer 4

Not all prices rise at the same time. If prices for goods increase faster than wages, then there will be unhappiness

Question 5

Trade Imbalances

Answer 5

Source of macroeconomic disruption and instability

Question 6

Aggregate Demand/Supply

Answer 6

• Model to explain economic growth tied to the unemployment rate
• Framework to study the connections and trade-offs between macro goals as well as the short-run fluctuations of GDP around long run trends

Question 7

Recession

Answer 7

Period of falling real incomes and rising unemployment. Technical def. - Real GDP decreases in tow consecutive quarters

Question 8

Depression

Answer 8

Severe Recession (very rare)

Question 9

Business Cycle

Answer 9

Relatively short-term movement of the economy in and out of recession

Question 10

Say’s Law

Answer 10

Supply creates its own demand - a given value of supply must create an equivalent value of demand

Question 11

Keynes’ Law

Answer 11

Demand creates its own supply

Question 12

Aggregate Supply

Answer 12

Positive relationship between the total quantity that firms choose to produce and sell and the price level for output holding the price of inputs fixed

Question 13

Potential GDP

Answer 13

Maximum quantity that an economy can (sustainably) produce given its existing levels of labor, physical capital, technology, and institutions. The unemployment rate is at the natural rate.

Question 14

Three Theories of AS-Curve

Answer 14

Actual output deviates from its natural rate (potential GDP) wen the actual price level deviates from the price level people expected

Question 15

Sticky Wage Theory

Answer 15

Nominal wages are sticky in the short run; adjust sluggishly due to long-term labor contracts or social norms - Higher P causes Higher Y, so the AS-curve slopes upward

Question 16

Sticky Price Theory

Answer 16

Many prices are sticky in the short run - due to menu costs (cost of printing new menues, the time required to change price tags) - Higher P is associated with higher Y, so the AS-Curve slopes upward

Question 17

Misperceptions Theory

Answer 17

Firms may confuse changes in P with changes in the relative price of the products they sell
If P rises above Pe, a firm sees its price rise before realizing all prices are rising. The firm may believe its relative price is rising, and may increase output and employment

Question 18

Aggregate Supply Curve

Answer 18

Y = Yn + a (P-Pe)
Y: Actual output
Yn: Natural Rate of output (potential GDP)
a > 0: measures how much Y responds to unexpected changes in P
P: actual price level
Pe: expected price level

Question 19

Aggregate Demand

Answer 19

The negative relationship between the total quantity of goods and services and the price level for output

Question 20

GDP Equation

Answer 20

Y = C + I + G + NX

Question 21

GDP Terms

Answer 21

C: Consumption, spending by households on goods and services (including education, but excluding new housing)
I: Investment, purchases of goods that will be used in the future to produce more goods and services (including new housing)
G: Government purchases, spending on goods and services by local, state, and federal governments (long form: government consumption expenditure and gross investment)
NX: Net Exports, foreign purchases of domestically produced goods (exports) minus the domestic purchases of foreign goods (imports).

Question 22

Extrapolating Macro Curve from Micro

Answer 22

Wealth Effect (price level and consumption C)
Interest-Rate Effect (price level and investment I)
Exchange-Rate Effect or Foreign Price Effect (price level and next exports NX)

Question 23

Wealth Effect

Answer 23

An increase in the price level lowers the real value of money and makes consumers less wealthy, which in turn discourages them to spend more. The decrease in consumer spending means a smaller quantity of goods and services demanded; vice versa

Question 24

Interest Rate Effect

Answer 24

A higher price level increases the interest rate, discourages greater spending on investment goods, and thereby decreases the quantity of goods and services demanded, vice versa.

Question 25

Foreign-Price Effect

Answer 25

When an increase in the US price level causes the relative price of US exports to increase and the relative price of imports from abroad to decrease, exports will decrease and imports will increase. Total net exports decrease and thereby decrease the quantity of goods and services demanded, vice versa.

Question 26

Exchange-Rate Effect

Answer 26

What an increase in the US price level causes US interest rates to increase, the real value of the dollar increases in foreign exchange markets. This appreciation dampens US net exports and thereby decreases the quantity of goods and services demanded.

Question 27

Stagflation

Answer 27

When an economy experiences stagnant growth and high inflation at the same time.

Question 28

What shifts the long term AS-Curve?

Answer 28

Changes in the labor force or the natural rate of unemployment Changes in physical or human capital Changes in natural resources Changes in technology

Question 29

AS-AD Model - Growth and Recession

Answer 29

- Long run economic growth due to productivity increases are represented by gradual shift of AS to the right - Potential GDP will gradually shift to the right as well - Factors that determine the speed of long run growth are not in the model - AS-AD model is a short run model: Recessions are illustrated in the AS-AD diagram when the equilibrium level of real GDP is substantially below potential GDP

Question 30

AS-AD - Unemployment

Answer 30

- Cyclical unemployment bounces up and down according to the short run movements of GDP - Diagram cyclical unemployment is shown by how close the economy is to potential (or full employment) GDP - Factors determine the natural rate of unemployment are not shown in the AS-AD diagram; they are implicitly part of what determines potential GDP

Question 31

AS-AD - Inflationary Pressure

Answer 31

AS-AD implies tow ways that inflationary pressure may arise - AD pushes to the right when the equilibrium is already close to potential GDP; pushing the equilibrium is already clost to potential GDP; pushing the equilibrium into the steep portion of the AS-curve - A rise in input prices (affecting many or most firms) causes AS-Curve to shift to the left

Question 32

AS-AD- Inflationary Pressure 2

Answer 32

AS-AD shows on one-time shift in price level. Why is inflation persistent over time? - Government continually attempts to stimulate economy by pushing AD up the AS-Curve - Inflation expectations can become built into the annual increase in prices and wages

Question 33

Review Questions on page 43 of slides

Answer 33

have you done them yet?

Question 34

Keynesian Perspective

Answer 34

Focuses on explaining why recessions and depressions occur. - Aggregate demand is not always automatically high enough to provide firms with the incentive to hire enough workers to reach full employment - Economy adjusts slowly to changes in AD because of stickiness of wages and output prices

Question 35

Keynesian Perspective - 2

Answer 35

A recession (equilibrium is to the far left of potential GDP) occures when AD is low far left). Importance of sticky wafes reflected by AS-curve that assumes constant (i.e. sticky) input prices. Sticky output prices reflected by a flat AS-curve. Changes in AD have little effect on price level (sticky output prices).

Question 36

Phillips Curve

Answer 36

The phillips curve shows the short-run trade off between inflation and unemployment Short Run: Fed Reserve can reduce unemploy rate below the natural unemply rate by making inflation greater than expected. Long Run: Expectations catch up with reality, unemploy rate goes back to natural unemploy rate whether inflat. is high or low.

Question 37

Phillips Curve Equations

Answer 37

Unemployment rate = Natural Rate of Unemployment - a( actual infl. - expected infl.)

Question 38

Phillips Summary

Answer 38

Describes the short-run tradeoff between inflation and unemploy Longrun: no tradeoff - inflation is determined by money growth, unemployment equals its natural rate Short run: supply shocks and changes in expected inflation - shifting the short run curve - making tradeoff more of less favorable Fed can reduce inflation by contracting the money suuply, which moves the economy along its short-run Phillips curve and raises unemployment. In the long run, expectations adjust and unemployment returns to its natural rate

Question 39

Neoclassical Perspective

Answer 39

- Real GDPi is potential GDP and the AS-curve is vertical line drawn at the level of potential GDP - Real GDP is equal to potential GDP regardless of AD - Changes in AD can have an impact on output and employment on short run - Over time, economic growth shifts protential GDP and the vertical AS (Long Run AS) gradually to the right - Prices and wages may be sticky in the short run, but they are flexible in the long run

Question 40

Rational Expectations

Answer 40

Theory that people form the most accurate possible expectations about the future that they can using all information available to them

Question 41

Adaptive Expectations

Answer 41

Theory that people look at past experience and gradually adapt their beliefs and behavior as circumstances change

Question 42

Answered Second Set of Questions at the end?

Answer 42

Done yet?