Chapter 28 Aggregate Supply and Demand

Question 1

What is stagflation?

Answer 1

A combination of unacceptably high inflation and rising unemployment.

Question 2

What does the aggregate demand curve represent?

Answer 2

The aggregate demand curve shows the relationship between the aggregate price level and the quantity of aggregate output demanded by households businesses the government and everybody.

Question 3

Why does the aggregate demand curve slope downward?

Answer 3

Because of the wealth effect and the interest rate effect.

Question 4

What is the effect on consumer spending caused by the effect of a change in the aggregate price level?

Answer 4

The wealth effect. (how inflation effects one’s nominal purchasing power)

Question 5

If a rise in the aggregate price level lowers aggregate purchasing power, how does this affect interest rates?

Answer 5

Interest rates rise because in order for people to purchase the same as before they must borrow or sell bonds.

Question 6

What is a rise in the interest rate due to increased aggregate price levels called?

Answer 6

The interest rate effect.

Question 7

What is the function of the AD curve?

Answer 7

To relate the overall demand for G&S to the overall price level. The aggregate spending at different price levels.

Question 8

What factors shift the AD curve?

Answer 8

Changes on expectations (consumer and business optimism or pessimism)
Changes in wealth (the real value of household assets)
The size of the existing stock of capital
Fiscal policy
Monetary policy

Question 9

What is fiscal policy?

Answer 9

How the gvt. Spends its money and taxes.

Question 10

What is monetary policy?

Answer 10

The central banks domain. Ie quantity of money supply etc.

Question 11

How does a change in the aggregate price level effect the AD curve?

Answer 11

It is movement along it.

Question 12

How does a change in wealth affect the AD curve?

Answer 12

It shifts it

Question 13

How do gvt. Changes in spending affect the AD curve?

Answer 13

Directly. Gvt. spending is included in the calculation of GDP therefore any increase in G is an equivalent increase in GDP.

Question 14

How does a change in taxes or gvt. transfers affect an economy?

Answer 14

Indirectly. They affect disposable income.

Question 15

How does increasing the money supply affect consumer spending?

Answer 15

It drives the interest rate down for any aggregate price level. This increases investment spending and consumer spending.

Question 16

How does a decrease in the money supply affect consumer spending?

Answer 16

It increases the interest rate. Is decreases investment spending and consumer spending.

Question 17

What is the prime rate?

Answer 17

The interest rate that banks charge their best customers.

Question 18

What is the function of the AS curve?

Answer 18

To show the relationship between aggregate price level and the quantity of aggregate output supplied in the economy.

Question 19

Define profitable output.

Answer 19

Profitable output = price per unit of output - production cost per unit of output

Question 20

What is it called when nomianl wages are slow to fall in the face of high unemployment and slow to rise in labor shortages?

Answer 20

Sticky wages. They are the result of the lag time involved in changing existing employment contracts.

Question 21

What is the short run aggregate supply curve?

Answer 21

The short run aggregate supply curve shows the relationship between the aggregate price level and the quantity of aggregate output supplied that exists in the short run, the time period when many production costs can be taken as fixed.

Question 22

What factors shift the aggregate supply curve?

Answer 22

Changes in commodity prices
Changes in nominal wages
Changes in productivity

Question 23

Why are commodities not included in the calculation of the aggregate price level?

Answer 23

They are not final products.

Question 24

What is the difference between short run and long-run aggregate supply curves?

Answer 24

There are no sticky wages in the long run. Changes in aggregate price level do not change the quantity of ever get up and supply in the long run. Changes in aggregate price levels affect not only the price of inputs but the outputs as well.

Question 25

What is potential output?

Answer 25

The level of real GDP economy would produce if all prices including wages were fully flexible.
Notated as Yp.

Question 26

Describe the interaction of the LRAS curve and the SRAS curve.

Answer 26

The economy is always on a point along the SRAS but it gravitates towards the LRAS. This is because the LRAS is the economy’s potential output.

Question 27

What is the point at which the quantity of aggregate output supplied is equal to the quantity demanded by domestic households, businesses, government, the rest of the world?

Answer 27

Short run macroeconomic equilibrium

Question 28

What is an event that shifts the aggregate demand curve call?

Answer 28

Demand shock

Question 29

Demand shocks cause price level and output to . . .

Answer 29

Move in the same direction.

Question 30

A supply shock moves the output and aggregate price levels. . .

Answer 30

Inversely. Ie. price levels fall but output increases

Question 31

What characterizes long-run macroeconomic equilibrium?

Answer 31

Aggregate demand is equal to short run aggregate supply and long-run aggregate supply or potential output.

Question 32

What is it called when aggregate output is below potential output?

Answer 32

A recessionary gap

Question 33

What is it called when aggregate output is above potential output?

Answer 33

An inflationary gap

Question 34

How is an output gap calculated?

Answer 34

Output gap = 100 x (actual aggregate output - Potential output)/Potential output

Question 35

What is the use of government policy to reduce the severity of recessions and rein in excessively strong expansions called?

Answer 35

Stabilization policy