ECON100 - Chapter 16 - Questions and terms from slides

Factors that shift aggregate supply

When commodity prices fall = supply increases

When nominal wages fall = supply increases

When workers become more productive = supply increases

Short-run macroeconomic equilibrium

When the quantity of aggregate output supplied is equal to the quantity demanded

This graph shows an equilibrium, E0, at a price level of P0 and an output of Y0. What do you think will happen to the AD curve when there is a decrease in consumer confidence or business confidence?

The AD curve will shift to the left

When an economy’s output increases and the price level increases, the ________ curve has shifted to the ________. (output is the same as real GDP so it is the x-axis and price is the y-axis)

AD; right

Demand shocks shift AD by

Moving the aggregate price level and aggregate output in the same direction

Supply shocks shift the SRAS by

moving the aggregate price level and aggregate output in opposite directions

Suppose that we observe a decrease in energy prices. How this would affect the aggregate demand - aggregate supply model?

SRAS; right

Long run macroeconomic equilibrium

When the point of short-run macroeconomic equilibrium is on the long run aggregate supply curve

Recessionary gap

When aggregate output is below potential output

Inflationary gap

When aggregate output is above potential output

Output gap

The percentage difference between actual aggregate output and potential output

Short run vs long run effects of a negative demand shock

In the long run the economy self corrects, demand shocks only have an effect on a short run aggregate output

negative demand shock, shifts AD leftward, economy moves to E2 and the recessionary gap rises. The aggregate price level and aggregate output both decline and unemployment rises.

But in the long run nominal wages fall in response to high unemployment, and SRAS shifts rightward and long run macroeconomic equilibrium is restored

Short run vs. long run effects on a positive demand shock

Starting at E1, a positive demand shock shifts AD rightward and the economy moves to E2 in the short run

This results in an inflationary gap as aggregate output and the aggregate price level both rise and unemployment falls

In the long run, nominal wages rise in response to low unemployment and SRAS1 shifts leftward and the economy returns to long run macroeconomic equilibrium 

Suppose an economy is in short-run equilibrium, but the level of real GDP is less than potential output. Which of the following statements is true?

In the long run, nominal wages will fall and the SRAS curve will shift right, restoring the economy to potential output.

Responding to supply shocks

A negative supply shock leads to a rise in prices and a rise in unemployment, which causes a dilemma

Stabilization of unemployment requires an increase in aggregate demand, which leads to inflation

Stabilization of prices requires a decrease in aggregate demand, which leads to higher unemployment

Suppose short-run equilibrium real GDP for an economy is greater than potential output. This implies that:

nominal wages will have to adjust upward as the economy moves from the short run to the long run.

the level of unemployment is very low.

jobs are plentiful.

to reach long-run equilibrium, the SRAS curve will shift to the left, resulting in a higher aggregate price level.

All of these are correct

Stabilization policy

The economy is self-correcting in the long run, but sometimes that takes a decade or more. It is recommended that the government not wait for it to self correct and fix it with monetary and fiscal policy.

Use government policy to reduce the severity of recessions and rein in excessively strong expansions

Policy in response to demand shocks

Policymakers can use monetary or fiscal policy to shift the aggregate demand curve back to the right

Policymakers may use fiscal or monetary policy to offset a fall in aggregate demand, but they must consider potential long term costs and uncertainties

Sticky wages

When wages adjust slowly in response to economic changes, leading to unemployment during downturns and decreased purchasing power during inflation

Fixed nominal wages (sticky wages) cause production costs to rise with output, which reduces supply, this is why SRAS slopes upward