Money & Banking Ch. 22 Flashcards

7 Factors that affect the Aggregate Demand Curve (all autonomous)

C (consumption)
I (planned investment)
G (government purchases)
T (taxes)
NX (net exports)
f (financial frictions)
r (real interest rate)

Shows the relationship between inflation and Real GDP

Aggregate Demand

Changing the real interest rate:
a. shifts the IS curve and shifts the AD curve
b. shifts the AD curve and moves along the IS curve
c. moves along the ad curve and shifts the IS curve
d. moves along the AD curve and moves along the IS curve

B; shifts AD, moves along IS

T/F A change in inflation shifts the AD curve

False; it moves along the AD curve

Using the attached image, draw a negative demand shock and show the effects

Demand curve shifts left, reducing aggregate output

AD curve

If autonomous real interest rate increases, aggregate output will

decrease

AD curve

If government purchases increases, aggregate output will

increase

AD curve

If Taxes increase, aggregate output will

decrease

AD curve

If autonomous net exports decreases, aggregate output will

decrease

AD curve

If autonomous consumption increases, aggregate output will

increase

AD curve

If autonomous investment decreases, aggregate output will

decrease

AD curve

If financial frictions decrease, aggregate output will

increase

This curve shows the relationship between the quantity of output supplied and the inflation rate

Aggregate supply curve

A vertical line that is determined by the amount of capital, labor, and available technology

Long Run Aggregate Supply (LRAS) curve

The LRAS curve is vertical at the _____ generated by the _____

The LRAS curve is vertical at the natural rate of output generated by the natural rate of unemployment

4 factors that shift the LRAS curve

Capital, Technology, Labor, Natural rate of unemployment

An increase in Capital would cause the LRAS to _____, which would effect aggregate output in what way?

shift right, increasing aggregate output

An increase in technology would cause the LRAS to ____, which would effect aggregate output in what way?

shift right, increasing aggregate output

A decrease in labor would cause the LRAS curve to ____, which would impact aggregate output in what way?

Shift left, decreasing aggregate output

An increase in the natural rate of unemployment would cause the LRAS to _____, which would impact output in what way?

shift left, decreasing output

An upward-sloping line based on 3 factors that drive inflation.

What are the three factors?

Aggregate Supply; Expected inflation, output gap, supply shocks

This kind of shock translates into price shocks which shift inflation that are INDEPENDENT of the slack in the economy

Price (supply) shocks)

3 factors that shift the Aggregate Supply curve

Expected inflation, supply shocks, a persistent output gap

AS curve

An increase in expected inflation would ____

shift the AS curve up

AS curve

A negative price shock would cause the AS curve to

shift up, increasing inflation and reducing output

AS curve

A positive price shock would cause the AS curve to

shift down, reducing inflation and increasing output

AS curve

An increase in a persistent output gap would cause the AS curve to

shift up, increasing inflation and reducing aggregate output

this mechanism claims that regardless of where output is initially, it’ll always return to the equilibrium natural rate of output.

Self-correction mechanism

When the self-correcting mechanism is slow,

Wages are _____ (flexible/inflexible)
Active government policy is _____ (needed/not needed)

Wages are inflexible
Active government policy is needed

When the self-correcting mechanism is rapid,

Wages and prices are _____ (flexible/inflexible)
Active government policy is _____ (needed/not needed)

Wages are flexible
Active government policy is not needed

Assume an aggregate demand shock where AD shifts right. What happens to the LRAS and AD equilibrium?

AS curve shifts upward to equilibrium causing a higher inflation rate.

(notice how it initially caused higher output, but in the long run it only increased inflation and output remained unchanged)

Aggregate Supply can shift from (2)

Define whether or not LRAS shifts from each

1. Temporary supply shocks (LRAS doesn’t shift)

2. Permanent supply shocks (LRAS does shift)

Assuming market equilibrium, draw a temporary negative supply shock. What would be the short term and long term impact?

Short term: Inflation increases, output decreases
Long term: No change in inflation or output

Assuming market equilibrium, what would happen in a temporary positive supply shock? What would be the short run and long run effect?

Short run: Fall in inflation, rise in output
Long run: No impact on inflation or output

Assuming market equilibrium, what would happen in a permanent negative supply shock? Draw the impact on the graph.

AS shifts up along the AD curve until equilibrium, causing permanent higher inflation and lower output

Assuming market equilibrium, what would happen in a permanent positive supply shock? draw the impact on the graph.

AS shifts down along the AD curve until equilibrium, causing permanent lower inflation and higher output

T/F a shift in aggregate demand curve affects output only in the short run, and has an effect in the long run

False; no effect on long run

T/F a temporary supply shock effects output and inflation only in the short run, and has no effect in the long run

True

T/F A permanent supply shock affects output and inflation both in short run and long run

True

T/F the economy has a self-correcting mechanism that returns it to natural output and potential rate of unemployment.

False; potential output and natural rate of unemployment