Macro Ch.20 – Flashcards

workers are laid off. firms may find they are unable to sell all they produce. factories are idle.

real and nominal variables.

in the long run, but not in the short run.

the slope of the aggregate-demand curve.

falls because falling prices increase the real value of a dollar.

decreases, so aggregate demand shifts left.

aggregate demand shifts right.

It would appreciate in foreign exchange markets making U.S goods more expensive compared to foreign goods.

because of contracts, social norms, and notions of fairness.

Both the price level and real GDP fall.

people will want to buy more bonds, so the interest rate falls. people are more willing to lend, so interest rates fall.

exports decrease, while imports increase.

The Fed conducted expansionary monetary policy.

3% per year on average.

• recessions: periods of falling real incomes and rising unemployment • depressions: severe recessions (very rare)

-Economic fluctuations are irregular and unpredictable. -Most macroeconomic quantities fluctuate together. -As output falls, unemployment rises.

model of aggregate demand and aggregate supply

long run, but not the short run.

changes in nominal variables (like the money supply or P ) can affect real variables (like Y or the u-rate).

the model that most economists use to explain short-run fluctuations in economic activity around its long-run trend.

The lower the price level, the less money households need to buy goods and services.

A lower price level in the United States lowers the U.S. interest rate.

-U.S. interest rates rise (the interest-rate effect). -Foreign investors desire more U.S. bonds. -Higher demand for $ in foreign exchange market. -U.S. exchange rate appreciates. -U.S. exports more expensive to people abroad, -imports cheaper to U.S. residents. Result NX falls

The dollars people hold buy fewer g&s, so real wealth is lower. People feel poorer. Result: C falls.

raises the real value of money and makes consumers feel wealthier, which in turn encourages them to spend more (because falling prices increase the real value of a dollar). The increase in consumer spending means a larger quantity of goods and services demanded

Buying g&s requires more dollars. To get these dollars, people sell bonds or other assets. This drives up interest rates. Result: I falls. (Recall, I depends negatively on interest rates.)

reduces the interest rate, encourages greater spending on investment goods, and thereby increases the quantity of goods and services demanded

when a fall in the U.S. price level causes U.S. interest rates to fall

the wealth effect (C falls) the interest rate effect (Inv. falls) the exchange rate effect (NX falls)

will shift the AD curve.

• Stock market boom/crash* • Preferences re: consumption/saving tradeoff • Tax hikes/cuts

• Firms buy new computers, equipment, factories • Expectations, optimism/pessimism • Interest rates, monetary policy • Investment Tax Credit or other tax incentives

• Federal spending, e.g. defense • State & local spending, e.g. roads, schools

• Booms/recessions in countries that buy our exports. • Appreciation/depreciation resulting from international speculation in foreign exchange market

is the amount of output the economy produces when unemployment is at its natural rate.

potential output or full-employment output

No

shift Long-Run Aggregate-Supply Curve (LRAS) Example: Immigration increases L, causing YN to rise.

• Immigration * • Baby-boomers retire • Govt policies reduce natural u-rate

• Investment in factories, equipment • More people get college degrees • Factories destroyed by a hurricane

• discovery of new mineral deposits • reduction in supply of imported oil • changing weather patterns that affect agricultural production

• productivity improvements from technological progress

shifts LRAS to the right and growth in the money supply shifts AD to the right. Result: ongoing inflation and growth in output.

1. The Sticky-Wage Theory* 2. The Sticky-Price Theory 3. The Misperceptions Theory

Imperfection: Nominal wages are sticky in the short run, they adjust sluggishly. • Due to labor contracts, social norms and notions of fairness . -Firms and workers set the nominal wage in advance based on (Expected Price Level) PE , the price level they expect to prevail.

Imperfection: Many prices are sticky in the short run. • Due to menu costs, the costs of adjusting prices. • Examples: cost of printing new menus, the time required to change price tags. Firms set sticky prices in advance based on PE.

If P > PE, revenue is higher, but labor cost is not. Production is more profitable, so firms increase output and employment. Hence, higher P causes higher Y, so the SRAS curve slopes upward.

Imperfection: Firms may confuse changes in P with changes in the relative price of the products they sell. If P rises above PE, a firm sees its price rise before realizing all prices are rising. The firm may believe its relative price is rising, and may increase output and employment. So, an increase in P can cause an increase in Y, making the SRAS curve upward-sloping.

In all 3 theories, Y deviates from YN when P deviates from PE.

1. Determine whether the event shifts AD or AS. 2. Determine whether curve shifts left or right. 3. Use AD-AS diagram to see how the shift changes Y and P in the short run. 4. Use AD-AS diagram to see how economy moves from new SR eq'm to new LR eq'm.

changes in the money supply have effects on real output in the short run only.

1. The Great Depression 2. The World War II Boom

Famous critique of classical theory: The long run is a misleading guide to current affairs. In the long run, we are all dead.