AD-AS

Question 1

Why can Business Cycles be bad for an Economy?

Answer 1

Recessions–> Unemployment

Booms–> Inflation + Bubbles (potentially)

Question 2

What is a Recession?

Answer 2

• Economic Contraction
• Period of Decreased Real Incomes + Increased Unemployment
  2 Consecutive Quarters of Negative Real GDP Growth

Question 3

What is a Depression?

Answer 3

Severe Recession

Question 4

What are the 3 main Facts about Economic Fluctuations?

Answer 4

1. Economic Fluctuations are Irregular + Unpredictable
2. Most Macroeconomic quantities fluctuate together
3. As Output falls–> Unemployment Rises

Question 5

What are the 2 main building blocks of Classical Economic Theory for SR Fluctuations?

Answer 5

Classical Dichotomy

Monetary Neutrality

Question 6

What is Classical Dichotomy?

Answer 6

Separating Nominal + Real Variables

Question 7

What is Monetary Neutrality?

Answer 7

Changes in M.S affect Nominal but NOT Real variables

- Can examine determinants of Real Variables without reference to Nominal variables

Question 8

According to Classical Economic Theory, what happens in SR?

Answer 8

Assumption of Monetary Neutrality- No longer appropriate
- Real + Nominal variables are intertwined
- Changes in M.S- can temporarily push Real GDP away from its LR trend
THEREFORE- Need a NEW SR Model

Question 9

What is Controversial about Real Business Cycle Theory?

Answer 9

Business Cycles occur Naturally- NOT due to Sticky Prices

- Trying to remove Cycles- Distort Market Mechanism- worsen situation

Question 10

What does the AD-AS model show?

Answer 10

Explains SR fluctuations in Economic activity around LR trend
- Focusses on relationship between Prices + Real GDP

Question 11

What does AD show?

Answer 11

Quantity of G+S Households, Firms, Gov. + Customers Abroad want to Buy at each Price Level

Question 12

What is the Price Level?

Answer 12

Aggregate Price Index- e.g. GDP Deflator, CPI etc.

Question 13

What 3 things explain why AD is Downward Sloping?

Answer 13

• Wealth Effect - C
• Interest-rate Effect - I
• Exchange Rate Effect - NX
  Assume G is a Fixed Policy

Question 14

What is the Wealth Effect?

Answer 14

Decreased Price Level –> Increased Value of Money –> Consumer feels Wealthier + Increases C –> Increased AD

Question 15

What is the Interest-rate Effect?

Answer 15

Decreased Price Level –> Need to hold less Money–> Reduced M.D –> Increases Private Savings–> Increased S of Loanable Funds–> Decreased I.R –> Increased I–> Increased AD

Question 16

What is the Exchange Rate Effect?

Answer 16

Fall in UK Price Level –> Decreased I.R–> Increased NCO + S of £ on FX Market–> Fall in £ ER–> Increased X + Decreased M–> Increased NX–> Increased AD

Question 17

If Price Levels Increase, what happens to C, I + NX?

Answer 17

1. Consumers Poorer- Decreased C
2. Increased I.R- Decreased I
3. Increased £ ER- Decreased NX
   Decreased Qd for G+S

Question 18

What is the relationship between P and QD for G+S?

Answer 18

NEGATIVE- AD Downward Sloping

Question 19

What can cause AD to Shift?

Answer 19

Changes in C, I, G + NX

Question 20

What changes in C can Shift AD?

Answer 20

Events that change how much people want to consume at a Given Price Level
- e.g. Change in Taxes, Wealth…

Question 21

What changes in I can Shift AD?

Answer 21

Events that change how much firms want to invest at a Given Price Level
- e.g. Better Technology, Changes in Taxes or M.S

Question 22

What changes in G can Shift AD?

Answer 22

Policy makers can change G at a Given Price Level

- e.g. Build new roads

Question 23

What changes in NX can Shift AD?

Answer 23

Events that change NX for a Given Price Level

- e.g. Recession in Trading Partners

Question 24

What does AS show?

Answer 24

Quantity of G+S firms Produce + Sell at a Given Price Level

Question 25

What is LRAS?

Answer 25

Price Level does NOT affect LR determinants of GDP - Supplies of Labour, Capital, Natural Resources + Technology matter for LRAS - Classical Dichotomy + Monetary Neutrality hold

Question 26

Where is LRAS Vertical?

Answer 26

At Natural Rate of Output | - Production of G+S in LR when Unemployment at NRU

Question 27

What causes a Shift in LRAS?

Answer 27

- Changes in Labour- immigration, births, policy to change Frictional + Structural Unemployment - Changes in Capital- affects Productivity - Changes in Natural Resources - Changes in Technology + Technological Knowledge

Question 28

What can shift in LR?

Answer 28

Both AD + LRAS

Question 29

What does Technological Progress lead to?

Answer 29

Continual Shift of LRAS to Right

Question 30

In LR- what type of Policy shifts AD to Right?

Answer 30

Monetary Policy

Question 31

What is the Result of AD + LRAS shifting to the Right?

Answer 31

Continuing Growth in Output | - Continuing Inflation

Question 32

In SR- how are Price Level + Qs of G+S related?

Answer 32

- Increased Price Level--> Increased Prices + Profitability--> Increased Qs of G+S - Decreased Price Level--> Decreased Prices + Profitability--> Decreased Qs of G+S

Question 33

What 3 things explain why SRAS is Upward Sloping?

Answer 33

- Sticky-Wage Theory - Sticky-Price Theory - Misperceptions Theory Cause Output to deviate from Natural Level due to Actual P ≠ Expected P

Question 34

What happens if P rises above Expected Level?

Answer 34

Output Increases ABOVE Natural Rate

Question 35

What is Sticky-Wage Theory?

Answer 35

- Nominal Wages- Slow to adjust to changing Econ. conditions- due to fact Labour contracts are fixed in Medium Term - Nominal Wages- based on Expected Prices- Do NOT respond immediately when Actual deviates from Expected

Question 36

Under Sticky-Wage Theory, what happens if Price Level < Expected Level?

Answer 36

Firms- Incentive to Reduce Output- Wages/Prices Higher than expected --> Increased CoPs--> Hire less workers

Question 37

Under Sticky-Wage Theory, what happens if Price Level > Expected Level?

Answer 37

Firms- Incentive to Increase Output- Wages/Prices Lower than expected --> Decreased CoPs--> Hire more workers

Question 38

What is Sticky-Price Theory?

Answer 38

Prices of some G+S: - Slow to Adjust + Menu Costs

Question 39

Under Sticky-Price Theory, what happens if Price Level < Expected Level?

Answer 39

Some Firms have Higher Prices than desired --> Decreased Sales + Decreased Output

Question 40

What is Misperceptions Theory?

Answer 40

Changes in Overall Price Level- can temporarily mislead supplier about changes in Individual Markets - Mistakenly Infer changes in absolute Prices as a change in Relative Prices - Suppliers respond to changes in level of Prices--> Changes in Qs of G+S

Question 41

Under Misperceptions Theory, what happens if Price Level < Expected Level?

Answer 41

Some suppliers might think this represents Reduced Relative Demand for their Product--> Reduced Output

Question 42

How is Qs calculated?

Answer 42

Qs = NRO + a( Actual PL - Expected PL ) | where a determines how much output responds to Unexpected changes in PL

Question 43

What happens to SRAS in LR + why?

Answer 43

In LR- Actual Prices = Expected Prices | --> SRAS = LRAS

Question 44

What causes a Shift in SRAS?

Answer 44

Changes in: Labour, Capital, Natural Resources, Technological Knowledge - Expected Price Increases--> SRAS LEFT Shift