Aggregate Demand & Aggregate Supply

These flashcards cover key concepts related to Aggregate Demand and Aggregate Supply, including their definitions, effects, and roles in fiscal and monetary policy.

What is the classical dichotomy?

The separation of real and nominal variables in the long run.

What is monetary neutrality?

The idea that the money supply affects only nominal variables and not real variables.

What is aggregate demand?

The total quantity of real GDP demanded at various price levels by all groups in the economy.

What does a shift in the aggregate demand curve to the north-east indicate?

An increase in consumption, investment, government purchases, or net exports.

What are the three explanations for the downward slope of the aggregate demand curve?

Interest rate effect, wealth effect, and open economy effect.

What is the interest rate effect?

A decrease in the price level leads to an increase in the supply of loanable funds, resulting in lower interest rates and increased investment.

What is the wealth effect?

A decrease in the price level increases consumers' real wealth, thus increasing the quantity of goods and services demanded.

What is the open economy effect?

A decrease in the price level leads to a depreciation of the real exchange rate, increasing net exports.

How does the short run aggregate supply curve differ from the long run aggregate supply curve?

The short run aggregate supply curve is upward sloping; the long run aggregate supply curve is vertical at potential real GDP.

What causes the profit effect in the short run aggregate supply curve?

Sticky nominal wages lead firms to increase production when the price level rises.

What is the misperceptions effect?

Producers respond to price changes in their markets based on misperceptions about the causes of those price changes.

Define menu costs effect.

Businesses are reluctant to change prices frequently due to costs associated with re-pricing, leading to decreased production when prices fall.

What is the natural rate of unemployment?

The unemployment rate when the economy is at potential real GDP; includes structural and frictional unemployment.

What is an inflationary gap?

The difference between potential real GDP and actual real GDP when the economy is overheating, leading to higher unemployment.

What fiscal policies can be used in a deflationary gap?

Increase government purchases, increase transfer payments, or decrease taxes to stimulate aggregate demand.

What are automatic stabilizers?

Fiscal policies that automatically increase or decrease with the economic cycle, such as unemployment insurance and welfare benefits.

What is the role of the Federal Reserve in monetary policy?

To manage the money supply and influence interest rates to stabilize the economy.

How does the Federal Reserve address a deflationary gap?

By increasing the money supply and decreasing interest rates to stimulate spending.

What is the effect of a contractionary monetary policy during an inflationary gap?

Decreased money supply raises interest rates, reducing consumption and investment, thus slowing down the economy.