Midterm 2 - AD-AS Model

Macroeconomic equilibrium

Occurs when quantity of output that buyers want to buy is equivalent to quantity of output that suppliers want to supply at a given price level

Why does aggregate demand slope downwards?

1. Wealth Effect - higher price level reduces purchasing power of nominal dollars = less consumption

2. Interest Rate Effect - high prices means people need more money —→ want to borrow from bank —→ high interest rates —→ investment becomes costly and decreases

3. International Trade Effect - high price levels means that other countries don’t want to buy from you anymore —→ decreases net exports

What does a shift in the aggregate demand curve mean?

at the same price level people will demand more of it

What is the AD equation

Y = C + G + I + NX

What increases C? (causes a shift)

1. More wealth - (stock boom, increased housing prices) —→ people have more money to spend so they spend it

2. Increased consumer confidence - if you’re confident you’re income will grow, spending today increases

3. Less taxes and increased government assistance (unemployment insurance)

4. Low interest rates

5. Less inequality - redistributing income will increase consumption; progressive taxation, transfer payments

What increases investment?

1. Expanding economy

2. Higher business confidence

3. Decreased corporate taxes

4. Easiness of obtaining a loan

5. High cash reserves

Basically anything that makes it profitable for a business to expand

What increases government purchases?

1. increased spending on goods/services

2. Automatic stabilizers

tbh the stuff here like unemployment insurance and social security increase through consumption not G

What increases NX?

1. Global economy growth

2. The exchange rate: US dollar depreciating means more countries want to buy from us which increases NX

3. Trade barriers: less trade barriers for foreign markets increases NX

Why does AS slope upwards?

Sticky Prices

What are sticky prices?

prices adjusting sluggishly to changing market conditions

What are the two types of sticky prices?

Sticky wages: wages and other input costs adjust slowly

Menu Costs: businesses have a marginal cost to change output prices so output prices are sticky

Because of sticky wages, businesses can profitably increase output for certain amount of time

What are menu costs?

Prices that businesses incur in order to change prices to higher price level (ex. changing price tags, printing “menus”)

When does AS shift?

If suppliers supply the same amount at a higher price

What shifts AS right?

1. lower input prices

2. Higher import prices raises production costs

3. Weaker productivity raises production costs: less output produced per unit (hour) of input

4. Depreciating US dollar means import costs rise; less imports bought than before

How do AD-AS shifts correspond to business cycles

more output = expansion

decreased output = recession