Week 8 - Aggregate Demand and Aggregate Supply

Question 1

economic fluctuations

Answer 1

• irregular and unpredictable
• most macroeconomic variables fluctuate together
• as output falls, unemployment rises
• fluctuations are often called the business cycle

Question 2

explaining short run economic fluctuations

Answer 2

• changes in the money supply affect nominal variables but not real variables in the long run
• the assumption of monetary neutrality is not appropriate when studying year to year changes in the economy
• changes in the money supply can temporarily push real GDP away from its long run trend

Question 3

aggregate demand curve

Answer 3

shows the total quantity of goods and services demand across all sectors at different price levels

Question 4

why the aggregate demand curve is downward sloping

Answer 4

• a decrease in the price level makes consumers feel wealthier, which in turn encourages them to spend more
• this increase in consumer spending means larger quantities of goods and services demanded
• a lower price level reduces the interest rate, which encourages greater spending on investment goods
• increase in investment spending means a larger quantity of goods and services demanded

Question 5

factors affecting quantity of goods

Answer 5

• consumption
• investment
• government purchases
  net exports

Question 6

aggregate supply curve

Answer 6

shows the total quantity of goods and services producers are willing and able to supply at different price levels

Question 7

why the aggregate supply curve is vertical in the long run

Answer 7

• an economy’s production of goods and services depends on its supplies of labour capital and natural resources and on the available technology used to turn these factors of production into goods and services
• the price level does not affect these variables in the long run

Question 8

why the aggregate supply curve slopes upward in the short run

Answer 8

• sticky wage theory
• sticky price theory
• misperceptions theory

Question 9

sticky wage theory

Answer 9

• nominal wages are slow to adjust
• wages do not adjust immediately to a fall in the price level
• a lower price level makes employment and production less profitable
• this induces firms to reduce the quantity of goods and services supplied

Question 10

sticky price theory

Answer 10

• price of some goods and services sluggishly in response to changing economic conditions
• an unexpected fall in price level leaves some firms with higher than desired prices
• this depresses sales, which induces firms to reduce the quantity of goods and services that they produce

Question 11

misperceptions theory

Answer 11

• changes in the overall price level temporarily mislead suppliers about what is happening in the markets in which they sell their output
• a lower price level causes misperceptions about relative prices
• these misperceptions induce suppliers to decrease the quantity of goods and services supplied

Question 12

long run equilibrium

Answer 12

• long run equilibrium is found where the aggregate demand curve intersects with the long run aggregate supply curve
• output is at its natural rate
• at this point, perceptions, wages and prices have all adjusted so that the short run aggregate supply curve intersects at this point as well

Question 13

effects of a shift in aggregate demand

Answer 13

• in the short run, shifts in aggregate demand cause fluctuations in the economy output of goods and services
• in the long run, shifts in aggregate demand affect the overall price level but do not affect output

Question 14

effects of a shift in aggregate supply

Answer 14

• output falls below the natural rate of employment
• unemployment rises
• price level rises

Question 15

stagflation

Answer 15

• a period of recession and inflation
• output falls and prices rise

Question 16

policy responses to recession

Answer 16

• do nothing and wait for prices and wages to adjust
• take action to increase aggregate demand using monetary and fiscal policy