Unit 3: Aggregate Supply and Demand

Demand-Pull Inflation

As demand for a good or service increases, producers must keep up the supply. If supply cannot keep up with demand, the price for the good increases.

These include an increase in consumer spending and investment, a sudden rise in exports, expectations of inflation, increase in government spending, expected inflation, and an excess of monetary growth.

Cost-Push Inflation

Occurs when a rise in input costs causes suppliers to reduce output at all given price levels. Caused by a decrease in SRAS

SRAS down, inflation up

Inflation rises, unemployment increases

Market Operations

The Federal Reserve’s activity of buying and selling securities in the open market to influence the money supply and interest rates.

Buying securities adds money from circulation, selling removes

Increasing operations stimulates eco growth by increasing lending and investment (demand)

Which of the following is NOT a part of per-unit production cost?

Price level

Included: Natural Resources, Input prices, Human resources, Capital resources

Positive supply shock

unexpected increase in the supply of a product or commodity, which can lead to lower prices and higher real GDP. Includes lower resource costs/wages

Supply vs Demand curves

Be careful with which one increased price/quanitity. The relationship of the slope is NOT the same as the relationship when a curve is shifted.

Monetary vs fiscal policy

Monetary is Fed Reserve: expansion/contraction of money supply, interest rates

Fiscal is Congress/President, includes purchasing/selling government bonds/transfer payments/gov spending/taxes

When a country's actual level of employment is less than their full employment level of output, this would be described as

Lower employment means recessionary gap

Inflationary gap vs expansionary period

Inflationary gap referes to difference between Real and Potential GDP (which is full employment). Expansionary period describes a phase in which the business cycle is growing (GDP is increasing)

Automatic stabilization

built-in budget mechanisms that automatically adjust taxes and spending to help stabilize the economy during economic downturn

Include taxes and benefit programs (welfare) - these are transfer payments

No action by the government needed, Keynesian economics concept. Increase AD

Stagflation

Stagnant and inflation, an economy characterized by high inflation, low economic growth and high unemployment

Can be caused by negative supply shock

Catch-up Effect

poorer economies will eventually catch up to wealthier economies in terms of per capita income (faster growth)

Progressive Income taxes

Take more from the rich than the poor, is an automatic stabilizer for inflation

Consumer expectations affect…

AD

Investment shifts aggregate demand when more expenditures are made on

capital goods

Factors of AS Curve

Change in input prices, Price of imported resources, changes of productivity, changes in legal regulation or business environment

Short vs long-run equilibrium

2 way intersection vs 3 way intersection

Expansionary policy corrects a….

recesionary gap

How to correct a recession

decrease taxes, increase government spending

Capital Stock

Capital stock is the level of physical capital in an economy.

Replacing equipment increases investment spending (AD)

Discretionary fiscal policy

changing spending or taxes to impact ecoomy

Effect of business taxes

lower SRAS, lower AD (investment)

Increasing taxes…

Decreases disposable income, decreasing AD. May also affect AS for businesses

What happens if there is no government action to a recession or inflationary state?

Long run correction: changes to wages, etc

Explain the negative relationship of AD with GDP

Real Wealth Effect: higher prices reduce purchasing power

Interest Rate Effect: when price goes up, lenders must charge more to get more real profit, which discourages spending

Exchange Rate Effect: rising domestic prices encourages greater domestic spending and lesser foreign spending, causing Xn to go down

Spending Multiplier

1/MPS

Tax Multiplier

MPC/MPS or (1/MPS)- 1

Shifters of SRAS

RAP

Resource Cost, actions of the government, productivity, expectations (workers demanding raise for impending recession, etc)

Negative supply shock

Key resource diminishes, causes stagflation when SRAS goes down

Self-adjustments ONLY have to do with what?

SRAS in short run, LRAS in long run. Economy is not really corrected by shifts to AD naturally

If AD shifts, what happens?

Eventually SRAS shifts to correct it by lowering wages and resource costs, bringing it back to long run equilibrium (albeit at a different point on the LRAS, could be lower or higher than the previous equilibrium)

Discretionary vs non-discretionary fiscal policy

Discretionary: takes time because of passing laws, affects AD through gov spending and taxation

Non-discretionary: permanent spending or tax laws enacted to work counter-cyclically to stabilize economy

Includes income tax, welfare/unemployment payments

Human capital causes a change in…

SRAS

What happens if AD increases in long run?

AS will eventually decrease to bring it back to LRAS, meaning prices will increase

What shifts: a decrease in interest rates which affects investment

AD increases, AND SRAS increases, meaning that LRAS must increase to match the increase of both (indeterminate price)

An increase in investment, technology or capital good spending leads to…

ECONOMIC GROWTH, meaning LRAS increases