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Flashcards in Chapter Eleven Deck (25):
1

Explain aggregate supply

Aggregate supply is the relationship between the quantity of real GDP supplied and the price level when all other influences on production plans remain the same. Other things remaining the same, when the price level rises, the quantity of real GDP supplied increases and when the price level falls, the quantity of real GDP supplied decreases.

The quantity of real GDP supplied is the total amount of final goods and services that firms in Australia plan to produce. The quantity of real GDP supplied depends on the quantities of labour employed, capital, human capital and the state of technology, land and natural resources and entrepreneurial talent.

At full employment: the real wage rate names the quantity of labour demanded equal to the quantity of labour supplied. Real GDP equals potential GDP. Over the business cycle: the quantity of labour employed fluctuated around its full employment level and real GDP fluctuates around potential GDP.

2

Explain the aggregate supply curve

Along the AS curve the only influence on production plans that changed is the price level.

All other influences on production plans remain constant. Among these other influences are the money wage rate and the money prices of other resources. In contrast, along the potential GDP line, when the price level changes the money wage rate changes to keep the real wage rate at the full employment level.

When the price level rises and the money wage rate is constant the real wage rate falls and employment increases. The quantity of real GDP supplied increases. When the price level falls and the money wage rate is constant, the real wage rate rises and employment decreases. The quantity of real GDP supplied decreases. That is why the AS curve slopes upward.

3

How to firms respond to change in the real wage rate

By changing the quantity of labour employed and the quantity produced. For the economy as a whole, employment and real GDP change. Three ways in which these changes occur are: firms change their output rate, firms shut down temporarily or restart production or firms go out of business or start up in business

4

Explain change in output rate

To change its output rate a firm must change the quantity of labour that it employs. If the price level rises and the money wage rate doesn't change an extra hou of labour that was previously unprofitable because profitable so the quantity of labour demanded increases and the output increases

5

Explain temporary shut downs and restarts

A firm that is incurring a loss might foresee a profit in the future so it might decide to shut down temporarily and lay off its workers. The price level relative to the money wage rate influences temporary shutdown decision. If the price level rises relative to the wage rate, fewer firms will shut down temporarily so more firms operate and the quantity of real GDP supplied increases.

6

Explain business failure and start up

When profits are squeezed or when losses arise more firms firm, fewer new firms start up and the number of firms decreases. The price level relative to the money wage rate influenced the number of firms in business. If the price level rises relative to the wage rate, profits increase, the number of firms increases and the quantity of real GDP supplied increases

7

Explain changes in AS

AS changes when any influence on production plans other than the price level changes. In particular AS changes when potential GDP changes, the money wage rate changes or the money prices of other resources changes

Anything that changes potential GDP changes as and shifts the curve. An increase in potential GDP shifts the potential GDP line rightward and the as curve shifts rightward.

A change in the money wage rate changes as because it changes firms costs. The higher the money wage rate the higher are firms costs and the smaller is the quantity that firms are willing to supply at each price level. So am increase in the money wage rate decreases aggregate supply. A rise in the money wage rate decreases as and the as curve shifts leftward but this rise doesn't affect potential GDP

A change in the money prices of other resources changes as because it changes firms costs. The higher the money prices of other resources the higher are firms costs and the smaller is the quantity that firms are willing to supply at each price level. So an increase in the money prices of other resources decrease as.

8

Explain aggregate demand

AD is the relationship between the quantity of real GDP demands and the price level when all other influences on expenditure plans remain the same. Other things remaining the same: when the price level rises, the quantity of real GDP demanded decreases. When the price level falls, the quantity of real GDP demanded increases.

The quantity of real GDP demanded is the total amount of final goods and services produced in Australia that people businesses govs and foreigners plan to buy. This quantity is the sum of the real consumption expenditure, investment, government expenditure on goods and services and exports minus imports

The quantity of real GDP demanded decreases when the price level rises and increases when the price level falls

9

What is the formula for ad

Consumption expenditure (C)

Investment (I)

Gov expenditure on goods and services (G)

Exports (X) minus Imports (M)

Y = C+ I + G + X - M

10

What is the ad price level influenced by?

The price level influences the quantity of real GDP demanded because a change in the price level brings changes in the buying power of money, the real interest rate and the real prices of exports and imports

11

Explain the buying power of money

A rise in the price level lowers the buying power of money and decreases the quantity of real GDP demanded

For example, if the price level rises and other things remain the same a given quantity of money will buy a smaller quantity of goods and services so people cut their spending

So the quantity of real GDP demanded decreases

12

Explain the real interest rate

When the price level rises the real interest rate rises

An increase in the price level increases the amount of money that people want to hold - increases the demand for money

When the demand for money increases, the nominal interest rate rises

In the short run the inflation rate doesn't change

So a rise in the nominal interest rate brings a rise in the real interest rate

Faced with a higher real interest rate business and people delay plans to buy new capital goods and consumer durable goods and cut back on spending so the quantity of real GDP demanded decreases

13

Explain the real prices of exports and imports

When the Australian price level rises and other things remain the same the prices in other countries do not change. So a rise In the Australian price lev makes Australian made goods and services more expensive relative to foreign made goods and services

This change in real prices encourages people to spend less on Australian made items and more on foreign made items

14

Explain changes in ad

A change in any factor that influences expenditure plans other than the price level brings a change in ad. When the ad increases the as curve shifts right but it shifts left when ad decreases.

Changes:
Expectations about the future : an increase in expected future income increase the amount of consumption goods that people plan to buy today and increases ad. An increase in expected future inflation increases ad today because people decide to buy more goods and services now before their prices rise. An increase in expected future profit increases the investment that firms plan to undertake today and increases ad.

Fiscal policy: gov uses this to influence ad; changing taxes, cash transfers from the gov and gov expenditure on goods and services.

Monetary policy: used by reserve bank to influence ad; changing the quantity of money and the interest rate

A tax cut or an increase in either cash transfers from the government or gov expenditure on goods and services increases ad. A cut in the interest rate or an increase in the quantity of money increases ad.

The world economy: the foreign exchange rate and foreign income influence ad. The foreign exchange rate is the amount of foreign currency you can buy with an Australian dollar. Other things remaining the same a rise in the foreign exchange rate decreases Australian ad. An increase in foreign income increases Australian exports and increases Australian ad.

15

When does ad increase and decrease

Increase
Expected future income, inflation or profits increase.
Fiscal policy or monetary policy actions increase planned expenditure

The exchange rate falls or foreign income increases

16

When does ad decrease

Expected future income, inflation or profits decrease

Fiscal policy or monetary policy actions decrease planned expenditure

The exchange rate rises or foreign income decreases

17

Explain the ad multiplier

The ad multiplier is an effect that magnifies changes in expenditure plans and brings potentially large fluctuations in aggregate demand. When any influence on ad changes expenditure plans: the change in e changes incomes, change in income induces a change in consumption expenditure and the increase in ad is the initial increase in expenditure plus the induced increase in consumption e.

18

Explain macroeconomic equilibrium

Occurs when the quantity of real GDP demanded equals the quantity of real GDP supplied. Occurs at the point of intersection of the ad and as curves.

19

What are the three types of macroeconomic equilibrium

Full employment equilibrium: when equilibrium real GDP equals potential GDP - occurs where the ad and as curves meet

Recessionary gap: a gap that exists when potential GDP exceeds real GDP and that brings a falling price level

Inflationary gap: a gap that exists when real GDP exceeds potential GDP and that brings a rising price level.

20

Explain economic growth and inflation trends

Economic growth results from a growing labour force and increasing labour productivity which together make potential GDP grow. Inflation results from a growing quantity of money that out places the growth of potential GDP. The ad-as model can be used to understand economic growth and inflation trends.

In as ad model; economic growth arises from increasingly potential GDP - a persistent rightward shift of the potential GDP line. Inflation arises from a persistent increase in aggregate demand at a faster pace than that of the increase in potential GDP - a persistent rightward shift of the AD curve at a faster pace than the growth of potential GDP

21

Explain the business cycle

The business cycle results from fluctuations in as and ad

As fluctuated because labour productivity grows at a variable pace, which brings fluctuations in the growth rate of potential GDP, the resulting cycle is called a real business cycle.

But the main source of the business cycle is ad fluctuations. The key reason is that the swings in ad occur more quickly than changes in the money wage rate that change as. The result is that the economy swings from inflationary gap to full employment to recessionary gap and back agai

22

Explain. Inflation cycles

The real GDP and inflation cycles interact .

23

Explain demand pull inflation

An inflation that starts because ad increases is called demand pull inflation

Any factor that increase ad can start an inflation but the only factor that can sustain it is growth in the quantity of money

Each time the quantity of money increases the as curve shifts rightward. Each time real GDP exceeds potential GDP the money wage rate rises and the as curve shifts leftward

A demand pull inflation results

24

Explain cost push inflation

An inflation that starts because as increases is called cost push inflation

Any factor that increases ad can start an inflation but the only factor that can sustain it is growth in the quantity of money

Each time a cost increases the as curve shifts leftward

Each time real GDP decreases to below potential GDP the reserve bank increases the quantity of money and the ad curve shifts rightward and a cost push inflation results

25

Exain deflation and the Great Depression.

During the Great Depression (1929-1933) the price level fell by 22 per cent and real GDP decreased by 31 per cent. During the 08-09 U.S. Recession real GDP fell by less than 4 per cent and the price level continued to rise although more slowly. During the Great Depression banks failed and the quantity of money fell by 25 per cent. No action was taken to counteract the fall of buying power so aggregate demand collapsed. Because the money wage rate didn't fall immediately Te decrease in ad brought large fall in real GDP. The money wage rate and price level feel eventually but not until employment and real GDP had shrunk to 75 per cent of their 1929 levels

During the 2008 financial crisis, U.S. Financial institutions were bailed out and the monetary base doubled. The quantity of menu kept growing. Also the government increased its own expenditures, which added to ad. The combined effects of continued growth in the quantity of money and increased government expenditure limited the fall in ad and prevented a large decrease in real GDP.

Challenge that now lies ahead is to unwind the monetary and fiscal stimulus as the components of robusta expenditure - consumption expenditure investment and exports being to increase. As these components return to more normal levels ad will increase. Too much monetary and fiscal stimulus will bring an inflationary gap and faster inflation. Too little monetary and fiscal stimulus will leave a recessionary gap.