Econ 282: Chapter 10 Economic Fluctuations

Question 1

Okuns Law

Answer 1

the negative relationship between GDP and unemployment
-unemployment rises during recessions and falls during expansions
-consumption and investment fluctuate with GDP, but consumption tends to be less volatile and investment more volatile than GDP

Question 2

Index of leading Economic Indicators

Answer 2

-Published monthly by the Conference Board of Canada
-Aims to forecast changes in economic activity six to nine months in the future
-used in planning by businesses and government, despite not being a perfect indicator

Question 3

Components of the LEI Index

Answer 3

-Average workweek in manufacturing
-claims received for employment insurance
-new orders for durable goods
-index of commodity prices
-money supply
-housing index
-U.S. leading indicator
-Index of stock prices

Question 4

Classical Macro Theory

Answer 4

-Output is determined on supply side: supplies of capital, labour, technology
-change sin demand for G and S only affect PRICES not quantities
-assumes complete price flexibility
-applies to the long run

Question 5

When prices are sticky…

Answer 5

-output and employment also depend on demand, which is affected by fiscal policy, monetary policy, and exogenous factors

Question 6

Aggregate Demand

Answer 6

-the aggregate demand curve shows the relationship between the price level and the quantity of output demanded

Question 7

The quantity equation as aggregate demand

Answer 7

MV=PY
-For M and V, this equation implies an inverse relationship between P and Y

Question 8

Why is the AD curve downward sloping

Answer 8

-Increase in the price level causes a fall in real money balances (purchasing power of money falls) and then because prices are high the demand for G and S is low

Question 9

Aggregate Supply in the Long Run

Answer 9

-in the long run, output is determined by factor supplies and technology
Y=F(K,L)
Ybar= the full employment or natural level of output at which the economy resources re fully employed.
Full employment means that unemployment equals its natural rate (not zero)

Question 10

Why is the long run aggregate supply curve vertical

Answer 10

In the long run, the economy reaches its full potential with all resources being used efficiently. No matter how much we produce, we can’t go beyond this maximum level in the long run. The LRAS curve is straight up and, showing that the economy can’t sustainably produce more than its full capacity

Question 11

Long Run Effects of A Decrease in M

Answer 11

1. A fall in aggregate demand, 2. lowers the price level in the long run
2. but leaves the output the same

Question 12

Aggregate Supply in the Short Run

Answer 12

-Many prices are sticky in the short run
-we assume all prices are stuck at a predetermined level in the short run
-firms are wiling to sell as much at that price level as their customers are willing to buy
-therefore, the SRAS curve is horizontal

Question 13

Short Run Effects of a Decrease in M

Answer 13

In the short run when prices are sticky, a fall in aggregate demand, lowers the level of output

Question 14

In the short run equilibrium, if Output is greater than full employment (Ybar), then over time P will…

Answer 14

RISE
-If the output is higher than the full-employment ut means that the economy is producing more than its sustainable capacity. Businesses may struggle t meet high demand, leading to rising prices over time.
-This happens because when demand exceeds what the economy can efficiently produce, sellers can charge more for their goods and services
-Everyone trying to buy something, not enough to supply, economy producing more than it can handle in short run, sellers charge higher prices, over time prices go up)

Question 15

In the short run equilibrium, if Y < Ybar, then over time P will…

Answer 15

FALL
-If total output (Y) is less than the maximum it could produce (Ybar), theres unused potential. When theres less tuff being made than what the economy can handle, businesses might feel desperate to sell their products. They might lower prices to attract more buyers,

Question 16

In the short run equilibrium, if Y = Y then over time P will…

Answer 16

REMAIN CONSTANT

Question 17

Shocks

Answer 17

exogenous changes in aggregate supply or demand
-shocks temporarily push the economy away from full employment

Question 18

The effects of a negative demand shock

Answer 18

-AD shifts left, depressing output and employment in the short run
-Over time prices fall and the economy moves down the demand curve towards full employment (LRAS)

Question 19

Supply Shocks

Answer 19

A supply shock alters production costs, affects the prices that firms charge (also called price shocks)
-Adverse supply shocks
-Bad weather reduces crop yields, pushing up food prices
-workers unionise, negotiate wage increases
-new environmental regulations require firms to reduce emissions. Firms charge higher prices to help cover the costs of compliance
-Favourable supply shocks lower costs and prices

Question 20

Stabilisation Policy

Answer 20

-policy actions aimed at reducing the severity of short run economic fluctuations
-using monetary policy to combat the effects adverse supply shocks.

Question 21

Stabilising Output with monetary policy

Answer 21

-The adverse supply shock moves the economy to point B
-The bank of Canada accommodates the shock cry raising aggregate demand
-P is permanently higher, but Y remains at its full employment level