AD & AS

Question 1

define aggregate demand

Answer 1

the total output of an economy during a period of time at a given price level

Question 2

components of aggregate demand

Answer 2

Consumption (C)
Investment (I)
Government spending (G)
Net exports (X–M)

Question 3

determinants of aggregate demand components

Answer 3

Consumption (C):
* consumer confidence
* interest rates
* wealth
* income taxes
* level of household indebtedness
* expectations of future price level

Investment (I):
* interest rates
* business confidence
* technology
* business taxes
* level of corporate indebtedness

Government spending (G):
* political priorities
* economic priorities

Net exports (X–M):
* income of trading partners
* exchange rates
* trade policies

Question 4

define aggregate supply

Answer 4

the total amount of goods and services provided in the economy at any given price level – shows the level of productive capacity of an economy

Question 5

define short-run aggregate supply

Answer 5

essentially all of the microeconomic supply curves summed up

Question 6

define long-run aggregate supply

Answer 6

the full employment level of output / potential GDP

Question 7

determinants of short-run aggregate supply

Answer 7

• Costs of factors of production (the short-run is defined as the period of time where the FOP do not change)
• Indirect taxes / subsidies

Question 8

what is the monetarist/new-classical view of aggregate supply

Answer 8

In the long run, the economy produces at the full employment level of output, indicating that in the long run the economy produces at potential GDP, which is independent of the price level.

Long-run equilibrium occurs when the SRAS and AD curves intersect on the LRAS curve at the level of full employment or potential output.

Question 9

what is the Keynesian view of aggregate supply

3 stages

Answer 9

There are 3 stages:

Stage 1:

• real GDP is low
• prices don’t go down because wages are sticky, therefore firms don’t lower prices
• prices don’t go up because of spare capacity
• because wages/prices are sticky, economies can get stuck in stage 1 (producing below potential GDP)

Stage 2:

• real GDP increases come with price level increases
• resources are beginning to be depleted and bottlenecks are occuring (spare capacity diminishes)
• as the price of resources increase, firms must raise their prices (to respond to shifts of the AD curve)

Stage 3:

• the AS curve becomes vertical
• the economy does not posses the resources that allow for more growth
• any effort by firms to increase production (any rightward shifts of the AD) results only in the price level increasing
• inflation and no growth

Question 10

what are inflationary gaps

Answer 10

when real GDP is greater than potential GDP (and unemployment is smaller than the natural rate of unemployment) due to excess AD

Question 11

what are recessionary/deflationary gaps

Answer 11

when real GDP is less than potential GDP (and unemployment is greater than the natural rate of unemployment) due to insufficient AD

Question 12

determinants of LRAS or Keynesian AS

Answer 12

• quantity and quality of FOP
• improvements in technology
• increases in efficiency
• institutional changes
• reductions in NRU

Question 13

assumptions of the monetarist/new-classical model

Answer 13

• wage and price flexibility (in the long run)
• the economy has a built-in tendency rowards full employment equilibrium
• changes in AD only influence GDP in the short run, in the long run it results in changes in the price level

Question 14

assumptions of the Keynesian model

Answer 14

• wage and price downward inflexibility
• the economy can get stuck in the short run
• economies have spare capacity
• markets don’t automatically return to full employment

Question 15

can the economy remain in long-run disequilibrium?

keynesian vs new classical

Answer 15

Possible in the Keynesian model, not in the monetarist

Question 16

how flexible are wages?

keynesian vs new classical

Answer 16

Keynesian:
Wages are sticky so the economy can get stuck in deflationary gaps

New classical:
inflationary/deflationary gaps are automatically corrected because wages are not sticky (prices can change)

Question 17

how effective are demand-side policies?

keynesian vs new classical

Answer 17

Keynesian:
Because AD can get stuck, govt should intervene to bring the economy back to Yp, without necessarily resulting in price increase

New classical:
Increases in AD always result in price increases

Question 18

how necessary is govt. intervention?

keynesian vs new classical

Answer 18

Keynesian:
It is necessary to intervene in the short run as well as the long run

New classical:
Focus only on policies that achieve long-term growth