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Why does the Aggregate-Demand Curve slope downward?
1. The Wealth Effect (least important) = a lower price level increases real wealth, which stimulates spending on consumption
2. The Interest Rate Effect (most important) = a lower price level reduces the interest rate, which stimulates spending on investment
3. The Exchange Rate Effect = A lower price level causes the real exchange rate to depreciate, which stimulates spending on net exports
Why does the AD Curve shift?
changes in consumption - due to changing consumer psychology, changes in wealth, and changes in government tax policy
changes in investment - due to changing beliefs about future business conditions, changes in the money supply, and changes in net exports
changes in government purchases - an increase in defense spending or on highway/mass transit, which is a rise in G
changes in net exports - The European recession leads to a fall in the purchase of US goods by Europeans and a fall in NX
What shifts AS in the long run? / What determines economy's real GDP?
- (numbers and human capital)
- (machinery, equipment, factories, new housing)
- Natural Resources
- Technological know-how
In the long run, technological progress shifts long-run aggregate supply (out to the right), and...
growth in the money supply shifts aggregate demand out to the left, leading to growth in output (Y shifts out to the right), and on going inflation (P shifts upward)
A decrease in the price level has what impact on quantity of output?
A decrease in the price level reduces the quantity of goods and services supplied in the short-run
Why does the LRAS curve vertical in the long run? Why might it shift?
vertical in the long run because of classical dichotomy and money neutrality
It might shift due to changes in the labor supply (e.g.,more immigration), changes in capital (increase in capital stock increases productivity, increasing supply of goods&services), changes in natural resources, or changes in tech knowledge
Why does the SRAS curve slope upwards?
sticky wages an unexpectedly low price level raises the real wage, which causes firms to hire fewer workers and produce a smaller quantity of goods and services
sticky prices an unexpectedly low price level leaves some firms with higher-than-desired prices, which depresses their sales and leads to them cutting back on production
Misperceptions an unexpectedly low price level leads some suppliers to think their relative prices have fallen, which induces a fall in production
Why might the SRAS curve shift?
- changes in labor increase in quantity of labor shifts AS to the right
- changes in capital increase in physical/human capital shifts AS to the right
- changes in natural resources increase in availability of natural resources shifts AS to the right
- changes in technology advance in tech knowledge shifts AS to the right
- changes in expected price level DECREASE in the expected price level shifts AS to the right
What is stagflation?
Stagflation is a period of falling output and rising prices
AD = C + I + (G-T) + NX
AD = C + I + (G-T) + NX
Liquidity Preference is...
Keyne's theory that the interest rate adjusts to bring money supply and money demand into balance
explains interest rate determination in an economy by the Supply and Demand for Money.
Amount of AD shift may be greater than or less than ↑G or ↓T. What are the two effects involved?
- Multiplier effect => AD shift is greater than deficit size
- additional shifts in aggregate demand that result when expansionary fiscal policy increases income and thereby increases consumer spending
- Crowd out effect => AD shift is less than deficit size
- The offset in aggregate demand that results when expansionary fiscal policy raises the interest rate and thereby reduces investment spending
What are automatic stabilizers?
changes in fiscal policy that stimulate aggregate demand when the economy goes into a recession without policy-makers having to take any deliberate action
Multiplier = 1/(1-MPC). Say the MPC=3/4, so that the Multiplier is equal to 4.
Using this, $20 billion of government spending generates how much in demand for goods and services?
$80 billion in demand
Ricardian Equivalence implies...
If people believe taxes will have to be raised in future to pay for debt then consumers reduce C to offset increased deficits.