Dynamic vs. Basic AD-AS Models & Fiscal Policy

Flashcards covering key comparisons between the basic and dynamic AD-AS models, as well as the effects and tools of expansionary and contractionary fiscal policy.

What key assumption distinguishes the dynamic AD-AS model from the basic AD-AS model regarding potential GDP?

The dynamic model assumes potential GDP (the LRAS curve) grows every year, whereas the basic model assumes potential GDP is static.

In both the basic and dynamic AD-AS models, what happens to the price level when expansionary fiscal policy is applied while the economy is below full employment?

The price level rises in both models.

According to the dynamic AD-AS model, when should policymakers use expansionary fiscal policy?

When aggregate demand is not growing fast enough and real GDP falls below potential GDP.

Which fiscal actions constitute expansionary fiscal policy?

Increasing government spending and/or cutting taxes.

In the dynamic AD-AS model, what is the main purpose of contractionary fiscal policy?

To slow overly rapid growth in aggregate demand and reduce inflation.

Which fiscal actions constitute contractionary fiscal policy?

Decreasing government spending and/or raising taxes.

If actual real GDP exceeds potential GDP, what type of fiscal policy is generally appropriate?

Contractionary fiscal policy.

If actual real GDP is below potential GDP, what fiscal policy should be applied?

Expansionary fiscal policy.

Keeping real GDP at potential in 2023 with expansionary policy would have what effect on inflation compared with taking no action?

It would raise the inflation rate (e.g., 4.2 % with policy vs. 2.5 % without).

How does successful expansionary fiscal policy affect unemployment?

It lowers the unemployment rate.

In the dynamic AD-AS framework, does deflation necessarily require a recession?

No; deflation can occur even without a recession.

What are the short-run effects of a successful contractionary fiscal policy?

Actual real GDP decreases, the price level falls, unemployment rises, and potential GDP remains unchanged.

Over time, which curve shifts right to reflect growth in potential output?

The long-run aggregate supply (LRAS) curve.

Besides LRAS, which other curves typically shift right each year in the dynamic AD-AS model?

The aggregate demand (AD) and short-run aggregate supply (SRAS) curves.

Name two policy tools Congress and the President can use to implement expansionary fiscal policy.

Increase government spending and/or cut taxes.

In the basic AD-AS model, what is assumed about potential GDP?

Potential GDP is fixed (static) unless explicitly changed.

What happens to unemployment when contractionary fiscal policy moves real GDP down to potential GDP?

Unemployment increases.

Complete the statement: "Over time, potential GDP , which is shown by the _ curve shifting to the right."

Increases; long-run aggregate supply