Econ exam 2

econ 202 chapters 13-16

Interest rates

(monetary policy) change of consumption, investment spending, & net exports

government purchases

(fiscal policy) changes government purchases

taxes

- income or business - (fiscal policy) change consumption or investments spending

expected future profitability

changes investment spending

foreign real gdp

changes net exports

foreign exchange rate

changes net exports

household wealth

changes consumption

expected future income

changes consumption

to understand what happens during the business cycle we need an explanation of what three things fluctuate

real gdp

unemployment rate

inflation rate

fluctuations in the unemployment rate are mainly caused by _____

the fluctuations in real gdp

in chapter 13 what model is used to explain short-run fluctuations in real gdp and the price level

aggregate demand and aggregate supply model

what is measured on the horizonal axis of the aggregate demand and supply graph (13.1) and what is measured on the vertical axis (by the gdp deflator)

Real GDP

Price level

The aggregate demand curve (AD) shows the relationship between

the price level and the quantity of real GDP demand by

house holds firms and government (both in and out of the country)

The short-run aggregate supply curve (SRAS)

shows the relationship in the short run between the price level and the quantity of real gdp supplied by firms

why is the aggregate demand curve downward sloping

gdp has 4 components - consumption (c ) investment (i) government purchases (g) net exports (nx)

it aggregate demand curve is downward sloping because a fall in the price level increases the quantity of real gdp demand.

equations y = c+i+g+nx (y stands for gdp)

______ is the most importnant variable determining consumption by households

current income

as total household wealth rises, ____ will rise

consumption

some household wealth is held in case or nominal assets that lose value as the _______ and gain value as the price level ______

price level rises

price level falls

when the price level rises, the _____ of household wealth declines, and so will consumption thereby reducing the quantity of ______ and _____ _____

real value

goods & services demanded

the effect of price level on consumption is called the __________

wealth effect

wealth effect is one reason that the aggregate demand curve is ____ sloping

downward

when prices rise, households and firms need more money to finance buying and selling and they try to increase the about of money they hold by ___________, _____________, or _________, such as______

and these actions tend to drive up _______ banks charge on _______ and the ______________

withdrawing finds from bank

borrowing from banks

or selling financial assets

such as bonds

interest rates

loans

interest rates on bonds

a higher interest rate raises the _________ for households and firms

and as a result forms will borrow less to build or install new machinery and equipment and house holds will borrow less to buy new houses/

cost of borrowing

A higher price level will ____ the interest rate and _____ investment spending, thereby _____ the quantity of goods and service demanded

increase

reduce

reduce

a lower price level will ______ rate and ________ investment spending, thereby ______ the quantity of goods and services demanded

decrease, increase, increasing

consumption will also ____ when interest rate ____ as households borrow ____ to finance spending on automobiles, furniture and the durable goods.

fall

rises

less

the effect of the price level on investment and consumption is known as the

interest-rate effect

the interest - rate effect is the second reason the aggregate demand curve is (up or down ward)____ sloping

downward

Net Exports

equals spending by foreign households and firms o goods and services produced in the united states minus spending by the US households and firms on goods and services produced in other countries.

Related to the net exports:

if the price level in the US Rises relative to the price levels in other countries, US exports will be come (more or less)_______ expensive and foreign imports will become relatively (more or less) __________ expensive

this could cause consumers in foreign countries to shift from _______________

US exports will ___ and US imports will ____ thereby ____ (increase or reduce) the quantity of goods and services demanded

and a lower price level in the US relative to other countries will have the (same ore reverse) _____ effect, causing net exports to (rise or fall) ____, thereby (increasing or decreasing) ___ the quantity of goods and services demanded.

more

less

from buying US exports to buying imported products

fall

rise

reducing

reverse

rise

increasing

the effect of price level on net exports is known as the

international-trade effect

the international trade effect is the third reason that the aggregate demand curve is _____ (up or down ward) downward sloping

downward

the interest rate effect refers to the fact that a higher price level results in (higher or lower) interest rates and (higher or lower) investments

higher interest rates and lower investments

the wealth effect refers to the fact that

• when income rises, consumption rises.

• when the price level falls, the nominal value of assets rises, while the real

• when the price level falls, the real value of household wealth rises, and so will consumption.

• All of the above

when price level falls, the real value of household wealth rises, and so will consumption.

the international-trade effect refers to the fact that an increase in the price level will result in a/n (increase or decrease) in exports and a/n (increase or decrease) in imports

a decrease in exports and an increase in imports

it is important to remember that the aggregate demand curve tells us the relationship between the price level and quantity of real GDP demanded, __________

holding everything else constant

if only the price level changes on the aggregate model and every other variable that affects the willingness of households, firms and the government to spend are unchanged, the result is a movement _____ (up/down (vertical) or (left /right (horizontal) along stationary aggregate demand curve.

If any other variable other then the price level changes the aggregate demand curve will shift.

for example if the government purchases increase and the price level remains unchanged the aggregate demand curve will shift to the ____(right or left) at every price level. OR if firms become pessimistic about the future of profitability of investments and cut back spending on factories, machinery, software, and computers, the aggregate demand curve will shift to the ____ (right or left)

up/down/vertical

right

left

if the price levels increase then the aggregate demand curve will shift to ____(left, right, move along a stationary aggregate demand curve, o r none of the above will happen)_____

there will be movement up along a stationary aggregate demand curve

the variables that cause the aggregate demand curve to shift fall into three categories

1. changes in monetary policy and fiscal policy

2. changes in the expectations of household and firms

3. changes in foreign variables

who uses the monetary policy and fiscal policy to shift the aggregate demand curve

the federal government

monetary policy refers to

the actions the federal reserve takes to manage the money supply and interest rates and ensure the flow of funds from lenders and borrowers

they do this to achieve macroeconomic policy objectives such as high employment, price stability, high rates of economic growth, and stability of the financial system

federal reserve is aka

the nation’s central bank

if the federal reserve takes actions that reduce interest rates, the cost to firms and household borrowing _____(rises or declines)

declines

lowering borrowing cost ____ (increase or decrease) consumption and investment spending , which shifts the aggregate demand curve to the ____ (right or left)

increases

right

fiscal policy refers to the

changes in federal taxes and purchases that are intended to achieve macroeconomic policy objectives

because gov purchases are one component of aggregate demand, and increase in gov purchases shifts the aggregate demand curve to the ____ (right or left) and a decrease in gov purchases shifts the aggregate demand curve to the (right or left)_____

right

left

an increase in personal income tax reduces households disposable income, which ____ (increase or reduce) consumption spending and shifts the aggregate demand curve to the ____(right or left). and a decrease in personal taxes shifts the aggregate demand curve to the _____(right or left)

reduce

left

right

an increase in business taxes reduces the profitability of investment spending and shifts the aggregate demand curve to the ___ (right or left)

a decrease in business taxes shifts the aggregate demand curve to the right

left

right

if households become more optimistic about their future incomes are they more likely to increase or increase their current consumption

and if they become pessimistic the demand curve will shift to the ________ (right or left)

(hint its the same for business)

increase

fun fact they are also more likely to increase spending on new houses, thereby increasing investment spending and this shifts the aggregate demand curve to the right

left

reduce the real value of household wealth _______ (increase or decrease) consumption

decrease

raises interest rates which _______ (increase or decrease) investment consumption

decreases

makes US export more expensive and foreign imports less expensive which, _______ (increase or decrease) net exports

decrease

If households and firms in other countries buy fewer U.S. goods or if households and firms in the United States buy more foreign goods, net exports will ____ (rise or fall) and the aggregate demand curve will shift to the ____ (right or left)

fall

left

When real GDP increases, so does the ________ available for consumers to spend.

income

If real GDP in the United States increases faster than real GDP in other countries, U.S. imports will ______ (increase or fall) faster than U.S. exports, and net exports will ___(increase or fall). Net exports will also ______ (increase or fall) if the exchange rate between the dollar and foreign currencies rises because the price in foreign currency of U.S. products sold in other countries will rise, and the dollar price of foreign products sold in the United States will ____ (increase or fall).

increase

fall

fall

fall

An increase in net exports at every price level will shift the aggregate demand curve to the _____ (right or left).

Net exports will _____ (increase or fall) if real GDP grows more slowly in the United States than in other countries or if the value of the dollar falls against other currencies.

A change in net exports that results from a change in the price level in the United States will result in a _____ (movement or shift) along the aggregate demand curve, not a _____ (movement or shift) of the aggregate demand curve.

right

increase

movement

shift

which of the following factors does not cause the aggregate demand curve to shift

a change in foreign variables

a change in government monetary pr fiscal policies

a change in the price level

a change in the expectations of households and firms

a change in the price level

how can government policies shift the aggregate demand curve to the right

by increasing government purchases

Long-run aggregate supply curve (LRAS)

shows the relationship in the long run between the price level and the quantity of real GDP supplied

the lras curve shifts right each year in figure 13.2

because the number of workers in the economy increases

the economy accumulates more capital

technological changes occurs

changes in the price level ______ (does or does not) affect the level of aggregate supply in the long run.

therefor the LRAS curve is a vertical line at the potential level of real GDP

does not

According to what economists believe, why do some firms adjust prices more slowly than others, and why might the wages of workers and the prices of other inputs change more slowly than the prices of final goods and services?

some firms and workers fail to accurately predict changes in the price level

if firms and workers could predict the future price level exactly, what would happen

the short-run aggregate supply curve would be the same as the long-run aggregate supply curve

But how does the failure of workers and firms to predict the price level accurately result in an upward-sloping SRAS curve?

the three most common explanations because the economists are not in complete agreement

contracts make some wages and prices sticky

firms are often slow to adjust wages

menu costs make some prices sticky

what sticky means relative to prices or wages

when they do not respond quickly to changes in demand supply

firms are often _____ (faster or slower) to cut wages than to increase them

slower

it can have negative effects on morale and productivity of workers can also cause some of the firms best workers to quit or/and look for other jobs

economist believe that the aggregate supply curve may be __________(vertical or horizonal) in the short run as well as long

vertical

the ____________ collects date on wages and helps economist gather info

Bureau of Labor Statistic (BLS)

Nominal wage

is the number of dollars a firm pays a worker

real wage

is the nominal wage divided by a price index

instead of of cutting wages during a recession, many firms tend to ____ the raises they give workers

reduce

if a firm freezes a workers nominal wage the workers real wage will gradually _______ (increase or decrease) over time due to ______

decrease

inflation

Truman Bewley, and economists at yale, says that the advantage of layoffs over pay reductions/cuts is that

they get misery out the door

firms base their price today partially based off of ___________

what they expect the future prices to be

why does the short-run aggregate supply curve upward

profits rise when the prices of the goods and services firms sell rise more rapidly than the prices they pay for inputs

why does the failure of workers and firms to accurately predict the price level result in an upward-sloping supply curve

because menu costs make some prices “sticky”

because contracts between workers and firms make some wages and prices “sticky”

because firms are often slow to adjust wages

because changes in the price level do not affect the number of works, the capital stock, or technology, in the long run, changes in the price ____ (do or do not) affect the level of real gdp

do not

remember that the level of real GDP in the long run is called _____ GDP or ________ GDP and at ______(the first blank)_____, firms will operate at their normal level of capacity and everyone who wants a job will have one, EXCEPT those workers who are structurally or fictionally unemployed. There is no reason for this normal level of capacity to change just because the price level has changed.

Potential

Full-employment

(first blank) potential

[keep in mind the difference between a shift of a curve and a movement along a curve.] the short-run aggregate supply curves tells us the short-run relationship between the _____ and the _____ of goods and services firms are willing to supply (holding constant all other variables that affect the willingness of firms to supply goods and services)

if the price level changes other variables are unchanged, the economy will move __________(up/down or left/right) along a stationary aggregate supply curve

if any variable other than price level changes the aggregate supply curve will (have movement along the curve or shift)

up and down

shift

what is the effect of an increase in the price level on the short-run aggregate supply curve?

a movement up along a stationary curve

the five most important variables that cause the short-run aggregate supply curve to shift

- increase in the labor force and in the capital stock

- technological change

- changes in the expected future price level

- adjustments of workers and firms to errors in the past expectations about the price level

- unexpected changes in the price of an important natural resources or occurrence of a natural disaster or pandemic

related to the variables that shift the short-run aggregate supply curve: increase in the labor force and in the capital stock

A firm will supply more output at every price if it has more ____ and more _____ _____. The same is true of the economy as a whole. So, as the labor force and the capital stock grow, firms will supply more output at every price level, and the short-run aggregate supply curve will shift to the ______.

ex: in China the birth rate has been low for decades which has caused the number of people of working age to decline, reducing the labor force, causing the short-run aggregate supply curve I=in China to shift to the _____.

workers

physical capital

right

left

related to the variables that shift the short-run aggregate supply curve: technological change

positive technological change leads to the productivity of ________ and _______ __(increasing or decreasing)_______, which means firms can produce more goods and services with the same amount of ______ and __________. this increase in productivity ____(increases or decrease)_ the firms costs of production and allows them to produces more output at every price level. this causes the short-run aggregate supply curve to shift to the ________.

workers

capital increasing

labor

capital

decreases

right

related to the variables that shift the short-run aggregate supply curve: changes in the expected future price level

if workers and firms believe that the price level is going to increase by 3% during the next year, they will try to adjust their ______ and ______ accordingly to preserve the _______ ______ of their wages.

the short-run aggregate supply curve will shift to the _____ so that any level of real GDP is now associated with a price level that is 3% higher.

In general if workers and firms expect the price level to increase by a certain percentage the SRAS curve will shift by an __________ _________ holding constant all other variables that affect the SRAS curve.

* if workers and firms expect that price will be lower in the future, the SRAS curve will shift to the ______

wages

prices

purchasing power

left

equivalent amount

right

related to the variables that shift the short-run aggregate supply curve: adjustments of workers and firms to errors in the past expectations about the price level

Workers and firms sometimes make incorrect predictions about the price level. As time passes, they will attempt to compensate for those errors.

If workers and firms across the economy are adjusting to the price level being higher than expected, the SRAS curve will shift to the _____. If they are adjusting to the price level being lower than expected, the SRAS curve will shift to the _____.

left

right

related to the variables that shift the short-run aggregate supply curve: unexpected changes in the price of an important natural resource or the occurrence of a natural disaster or pandemic

Supply shocks are often caused by unexpected increases or decreases in the prices of important natural resources that cause firms’ costs to be different from what they had expected.

an ex: this product can cause a supply shock: _____ prices can be particularly volatile. _________ __________ or _________ can also result in a supply shock

Because firms face rising costs, they will supply the same level of output only if they receive higher prices, and the short-run aggregate supply curve will shift to the ______.

The U.S. economy has experienced at least some inflation every year since the 1930s, and workers and firms always expect next year’s price level to be higher than this year’s price level. Holding everything else constant, expectations of a higher price level will cause the SRAS curve to shift to the ______. But everything else is not constant because every year, the U.S. labor force and the U.S. capital stock expand and changes in technology occur, and these factors cause the SRAS curve to shift to the _____. Whether in any particular year the SRAS curve shifts to the left or to the right depends on the size of the effect these variables have during that year.

oil

natural disasters

pandemics

left

left

right

supply shock

is an unexpected event that causes the short-run aggregate supply curve to shift

which of the following causes the short-run aggregate supply curve to shift to the right?

a. a decrease in the capital stock

b. a positive technological change

c. an increase in the expected price of an important natural resource

d. a higher expected future price level.

b. a positive technological change

which of the following causes the short-run aggerate supply curve to shift to the left?

a. an increase in the expected price of an imporntant natural resource

b. a positive technological change

c. an increase in the labor force

d. an increase in productivty

a. an increase in the expected price of an important natural resource

Because the full analysis of the aggregate demand and aggregate supply model can be complicated, we begin with a simplified case, using two assumptions:

the economy has not been experiencing any inflation. the price level is currently 115, and workers and firms expect it to remain at 115 in the future

the economy is not experiencing any long-run growth. potential GDP is $20.0 trillion and will remain at that level in the future

this assumption allows us to understand more easily the key ideas of the aggerate demand and aggregate supply model. especially when examining the short-run and long-run effects of recessions, expansions, and supply shocks. these assumptions are simplifications because in reality the US has experienced inflation and GDP increase every year.

after a recession economists refer to the process of adjustment back to potential GDP just described as

an automatic mechanism

b/c it occurs without any actions by the government

higher interest rates ________ (increase or reduce) consumer demand for new houses by ______ (increasing to reducing) the cost of loans

reduce

increasing

expansion

Real GDP will be above potential GDP: Firms are operating beyond their normal level of capacity, and some workers who would ordinarily be structurally or frictionally unemployed or who would not be in the labor force are employed.

If the economy is initially at full-employment equilibrium, then an increase in aggregate demand causes _____________ in real GDP in the short run and ___________ in the price level in the long run.

increase'

increase

If the economy adjusts through the automatic mechanism, then a decline in aggregate demand causes

A. a recession in the short run and a decline in the price level in the long run.

B. an expansion in the short run and an increase in the price level in the long run.

C. an expansion in the short run and a decline in the price level in the long run.

D. a recession in the short run and an increase in the price level in the long run.

A. a recession in the short run and a decline in the price level in the long run

Which of the following is usually the cause of stagflation?

A. a supply shock as a result of an unexpected increase in the price of a natural resource

B. an increase in investment as a result of a reduction in interest rates

C. a reduction in government purchases

D. a decline in net exports as a result of a change in the exchange rate

A. a supply shock as a result of an unexpected increase in the price of a natural resource

stagflation

an uncommon and challenging economic condition characterized by the simultaneous occurrence of high inflation, slow or negative economic growth (stagnation), and elevated unemployment

The Covid-19 pandemic resulted in

both an aggregate supply shock and an aggregate demand shock.

we can create a dynamic aggregate demand and aggregate supply model by making changes to the basic model that incorporate the following important macroeconomic facts

potential GDP increases continually, shifting the long-run aggregate supply curve to the right

during most years, the aggregate demand curve shifts to the right

except during periods when workers and firms expect high rates of inflation, the short-run aggregate supply curve shifts to the right

infation

If total spending in the economy grows faster than total production, prices rise.