Econ 2020 Ch 9 Pre built – Flashcards

1)When aggregate demand falls, in response firms lower production and lay off workers. This causes people's income to fall, thus lowering consumption expenditures further and causing firms to lower production. This downward spiral leads to an equilibrium where output is lower than potential output. 2)When aggregate demand is high, in response firms increase production and hire workers. This causes people's income to increase, thus increasing consumption expenditures further and causing firms to increase production. This upward spiral leads to an equilibrium where output is greater than potential output.

When prices are falling, profits decline, making entrepreneurs hesitant to start businesses, slowing the growth of the economy. Asset values (prices of assets such as houses, stocks, and bonds) also decline, thus reducing the value of collateral used to support consumer and producer loans and therefore spending. So both types of deflation undermine business and consumer confidence.

If the paradox of thrift holds, increasing savings will lower aggregate income and set in motion a cycle of declining expenditures and production. This will reduce income far enough so that once again saving and investment will be in equilibrium, but then the economy will be in an almost permanent recession, with ongoing unemployment. Keynesians believe that in this case the economy will need government's help to prop up aggregate expenditures.

One expects the AD curve to be vertical because when the price level rises, all prices rise together. That is, since wages have risen as much as prices for consumer goods, no relative prices have changed and therefore people's decisions to consume should not change either.

A rise in the price level reduces the value of cash people are holding. To keep the real value constant, they withdraw more from their banks. This reduces the amount banks have to lend, which leads to higher interest rates and lower investment expenditures.

Assuming fixed exchange rates, a rise in the price level makes goods less competitive internationally, decreasing exports.

The money people hold in cash is worth less, which decreases spending.

(1) Changes in foreign income, (2) changes in expectations, (3) changes in exchange rates, (4) changes in the distribution of income (5) changes in governmental aggregate demand policy.

1.If the price level falls, it creates expectations of falling aggregate demand. 2.If the price level falls, it lowers asset prices.

The AD curve becomes steeper.

The AD curve becomes steeper.

The AD curve becomes steeper.

The AD curve shifts to the right.

The AD curve shifts to the right by a multiple of 20.

The AD curve shifts to the left by a multiple of 10.

1. Changes in productivity. 2.Changes in input prices.

The SAS curve will shift up, since wages rise by more than the rise in productivity.

The SAS curve will shift down, since productivity rises by more than the rise in wages.

The SAS curve will shift up, since wages rise and productivity declines.

The SAS curve will not shift, since the wage increase is exactly offset by a productivity increase.

Because output is independent of the price level.

The LAS curve will shift to the right, and the SAS curve will not shift initially.

The LAS curve will shift to the left, while the SAS curve will shift up

The SAS curve will shift up, and the LAS curve will not shift.

Underutilization, fall, down, fall,increasing

The price level falls and output rises.

a. Price level may increase or decrease and output decreases. b. expansionary monetary and fiscal policies

Increase spending while decreasing taxes (expansionary fiscal policy).

Decrease spending while increasing taxes (contractionary fiscal policy).

Increase spending while decreasing taxes (expansionary fiscal policy).

1. falling asset prices reduce perceived wealth 2. banks call in loans as asset values fall 3. People expect aggregate demand to fall

Knowing where the economy is relative to potential output tells you whether to implement expansionary or contractionary policy.

Without knowing potential income, we cannot know whether to use expansionary or contractionary policy. The model does not take into account the difficulties in implementing fiscal policies. The model does not take into account the uncertain effectiveness of fiscal policies. The model does not take into account dynamic price level adjustment feedback effects.

It is difficult to assess the condition of the economy at any one time. It takes a long time to enact new government policies. Politically it is difficult to raise taxes, even when countercyclical policy is contractionary.