AS prices and adjustments to shocks Flashcards
(15 cards)
What does the classical model assume about output
Output is always at its long-run equilibrium level, and deviations are corrected by price and wage adjustments
Why do central banks not target zero inflation
Because in the short run, prices and wages may not be fully flexible, so inflation targeting helps stabilize aggregate demand
How does the central bank set the real interest rate
It forecasts inflation and then sets nominal interest rates to achieve the desired real interest rate
What determines the slope of the AD schedule
The responsiveness of interest rate decisions to inflation and the impact of interest rates on aggregate demand
What causes shifts in the AD curve
Fiscal expansion, changes in net exports, and monetary policy adjustments
What happens to real output when inflation increases, assuming flexible wages and prices
There is no change in real output or employment; nominal wage rises at the same rate as inflation
How is equilibrium inflation achieved
The central bank adjusts interest rates to align inflation with its target
What is the effect of a positive supply shock
It is deflationary, as productivity increases and prices drop
What does the rr schedule represent
It shows the central bank’s monetary policy stance, where a looser policy shifts it downward, lowering interest rates
How does an increase in government spending (G) affect the economy
It shifts the IS schedule, influencing aggregate demand and potentially shifting the AD curve
What does monetary neutrality mean
Changes in nominal quantities (money supply, inflation) do not affect real variables like output or employment in the long run
What determines potential output in the classical model
The quantities of factors of production (capital, labour, land) and the efficiency with which they are used
How does inflation affect the willingness of firms to supply output
If wages and prices rise at the same rate, real wages remain unchanged, so firms’ willingness to supply output is unaffected
What determines equilibrium inflation in the economy
The intersection of the aggregate demand and aggregate supply curves, influenced by central bank policy adjustments
What is the effect of a negative supply shock
It is inflationary, as it raises production costs (e.g., higher oil prices leading to higher consumer prices)
