Week 8 - AS-AD Model

Question 1

What is Say’s Law

Answer 1

Classical economists clam that whatever is produces would be consumed (mainly due to the circular flow)

Question 2

What does Keynes say about Say’s Law

Answer 2

Keynes argues that supply is largely driven by the expected extent of future demand, if suppliers mis estimate future AD it is possible some output may be unconsumed

Question 3

What does the as-ad model do?

Answer 3

Attempts to explain short-run fluctuations in real GDP and the price level. The AD curve shows the price level and quantity of real gdp demanded in the economy (AS shows this supplied). This relationship between nominal prices and real output violates the classical dichotomy.

Question 4

Why does the As-ad model violate the classical dicothomy>

Answer 4

There is a relationship between nominal prices and real output. It is a short-run model where lags and rigidities in adjustment lead to nominal quantities having real effects

Question 5

Factors that mead the demand curve has a negative slope?

Answer 5

1) wealth effect (change in price level affects real wealth and consumption)
2) interest rate effect (change in price level affects real interest rate and investment)
3) international trade effect (change in price level impacts relative price of foreign and domestic goods and net exports)

Question 6

What does a movement along the AD curve show

Answer 6

a movement holds everything constant and shows what real GDP will be given different possible price levels as driven by the components of AE and how these are affected by prices

Question 7

Impact of higher interest rates on AD

Answer 7

shift to the left as cost of borrowing rises, reducing C and I

Question 8

Impact of higher gov purchases on AD

Answer 8

Shift to the right as G is a component of AD

Question 9

Impact of higher taxes on AD

Answer 9

shift to the left as C falls with higher income tax and I falls with companty tax

Question 10

Impact of better household income expectations on ADq

Answer 10

Shift to the right as consumption increases

Question 11

Impact of better firm expectations of profitability on AD

Answer 11

Shift to the right as investment increases as they believe it will be more profitable

Question 12

Impact of higher relative domestic growth on AD

Answer 12

Shift to the left as exports fall

Question 13

Impact of a higher exchange rate on AD

Answer 13

Shift to the left as imports increase and exports fall

Question 14

What can shift the long run aggregate supply curve?

Answer 14

Vertical line at potential GDP can shift with the labour force, amount of machinery and equipment or technology

Question 15

Why is the SRAS upwards sloping?

Answer 15

firms produce more in response to higher prices. This is because input prices typically rise slower than final prices (due to sticky wages and prices, firms being slow to adjust wages and menu costs)

Question 16

What is the money illustion

Answer 16

People misread inflation in the short run leading to a temporary illusion as to the real value of money. Firms will invest more if they think inflation is lower

Question 17

Why are wages sticky and relationship to output?

Answer 17

contracts and social conventions.
If actual inflation is less than expected, output falls as real wages are higher. Inflation is associated with higher output.

Question 18

Why are prices stick and relationship to output?

Answer 18

Some goods have long-term contracts or complex pricing schemes. If inflation is higher than expected, real prices are lower stimulating demand and output.

Question 19

Impact of higher labour force or capital stock on AS

Answer 19

Shift to the right as more output can be produced at each price level (same for resources)

Question 20

Impact of higher productivity on AS

Answer 20

Shift to the right as costs of producing each unity of output falls

Question 21

Impact of higher expected future price level on AS

Answer 21

shift to the left as costs of producing rise

Question 22

Impact of workers/firms adjusting to previously underestimated price level?

Answer 22

Shift to the left a workers are firms increase wages and prices

Question 23

Impact of higher expected price of an important natural resource

Answer 23

Shift to the left as costs of producing increase

Question 24

What is equilibrium in the AD-AS model

Answer 24

place where LRAS, SRAS and AD intercept. Actual output is equal to LR potential output and there if full employment and no underutilised capacity.

Question 25

Neo classical and Keynes aspects of AS-AD model

Answer 25

Assumed long run equilibrium will always hold (NC) but short run deviations possible (K)

Money is neutral in long run (NC) but nor in short run (K)

Both supply and demand determine output (K) but only supply determines long run output (NC)

Economic agent expectations have short run implications for output and prices (K) but not in long run (NC)

Question 26

What is the y intercept in the Ae model

Answer 26

autonomous consumption

Question 27

Difference between micro demand and aggregate demand

Answer 27

Micro demand relates to the willingness to pay for an individual good from individual curves. AD relates to AE and the price level on an economy wide level

Question 28

Why is SRAS sloping

Answer 28

money is not neutral in the short run. Higher prices mean firms tend to produce more as they receive more (wages and capital are sticky). In the long-run, firms must adjust these and producing more or less won’t change anything

Question 29

Difference between micro and aggregate supply

Answer 29

From the micro point of view, supply is the marginal cost curve rather than relating to the price of L and K

Question 30

Define demand inflation

Answer 30

higher demand result in a rightwards shift in AD. This results in higher inflation and higher output. E.g. the mining boom

Question 31

Define cost inflation

Answer 31

Higher production costs lead to SRAS shifting left, higher inflation and lower output.