Topic 7

Question 1

Consumption growth and investment growth both fluctuate with GDP, which is more volatile?

Answer 1

Investment

Question 2

What does Okun’s Law describe?

Answer 2

The negative relationship between GDP and unemployment

Question 3

See

Answer 3

slide on real GDP, C, I and U

Question 4

2 reasons consumption is less volatile than investment?

Answer 4

1) consumers save tf buffer to shocks to GDP and income

2) also consumers try to ‘smooth out’ income across lifetime

Question 5

Why is investment growth more volatile than GDP growth?

Answer 5

Accelerator effect:

When an increase in GDP -> proportionately larger increase in Investment

Question 6

Why does the accelerator effect occur?

Answer 6

When firms believe that demand is growing and will continue to grow, they tend to overcompensate in investment because they don’t want to be caught without stock to provide

Question 7

Draw Okun’s law diagram

Answer 7

See topic 7 slide 6

Question 8

See

Answer 8

Notes: recap of classical macro theory

Question 9

What does AD curve show?

Answer 9

Relationship between price level and quantity of output demanded

Question 10

What implies the DWS AD curve?

Answer 10

MV=PY

If MV constant, increase in P means decrease in Y and vice versa

Question 11

How would an increase in money supply affect AD curve?

Answer 11

Shift it right (change in V would also affect the curve)

Question 12

Mechanism that builds the AD curve?

Answer 12

Increase in price level -> decrease in RMB -> decrease in D for G and S

Question 13

See

Answer 13

AS stuff bottom of side 1 page 1

Question 14

What are the SRAS and LRAS curves like and why?

Answer 14

SR: flat; all prices fixed in SR, firms willing to sell as much as consumers wish to buy

LR: vertical; prices fully flexible, output determined by the fixed supply of K and L, not by demand

Question 15

Draw and explain the SR and LR effects of an increase in the money supply?

Answer 15

Shifts AD right;
SR: P constant, Y increases
LR: P rises, Y returns to natural level
see notes for diagram

Question 16

Draw and explain the SR and LR effects of a negative demand shock?

Answer 16

See notes

Question 17

What are supply shocks?

Answer 17

Shocks that alter production costs, also called price shocks

Question 18

See examples of adverse and favourable supply shocks

Answer 18

notes now

Question 19

Explain part 1 of the 1970s oil price shocks?

Answer 19

Early 70s, OPEC coordinates a reduction in the supply of oil -> increase in prices (11% in ‘73, 68% in ‘74, 16% in ‘75)
Increase in price -> increase in SRAS -> fall in Y and rise in U
Over time, prices fell back to point A
Draw diagram to show this and see notes

Question 20

Explain part 1 of the 1970s oil price shocks?

Answer 20

BUT in late 70s prices shot back up due to supply shock, in 1980s there was a favourable shock that then reduced the prices of oil and returned inflation and U back to natural levels

Question 21

What is stabilization policy?

Answer 21

Policy aimed at reducing the severity of SR fluctuations

Question 22

Example of stabilization policy?

Answer 22

Using monetary policy to combat the effects of adverse supply shocks

Question 23

See

Answer 23

diagram at end of notes