test 3 - aggregate demand and aggregate supply

what is the AD curve?

The AD curve represents the total expenditures in the economy. It is the GDP by the expenditure approach. It consists of consumption expenditures plus government purchases plus gross investment plus net exports.

what are the coordinates on the graph for the AD curve?

The coordinates on the graph for the AD curve are on the vertical axis the price level and on the horizontal axis total expenditures or the GDP.

what is the slope of the AD curve? why does it slope in that direction?

The AD curve slopes downward, showing an inverse relationship between the price level and the aggregate amount spent.

It slopes downward for 3 reasons:

• interest rate effect

• a real balances effect

• a foreign purchases effect.

when would there be an upward movement on the AD curve

there would be an upward movement on the AD curve if the price level increased

why might the AD curve shift?

• change in income

• change in wealth

• change in expectations

• change in taxes

• change in interest rates

changes in the price level would not cause the shift of the curve but it would cause a movement on the curve

If the AD curve shifts, what happens to the equilibrium or the coordinates on the graph?

The effect on the equilibrium price level and amount of output will depend on where the AD curve started on the AS curve and where it ended on the AS curve.

What is a ratchet effect? What is the significance of a ratchet effect?

A ratchet effect means that a leftward shift of the AD curve will not lower the price level but rather the price level will remain the same.

The significance of the ratchet effect is that if the price level remains the same, rather than decreases, output and employment will decline more than they otherwise would and this can worsen a recession.

What does the AS curve represent?

The AS curve represents total output by the total amount of income generated. It is total wages plus total profits plus total rent plus total interest added together. It is the payment to the factors of production. It assumes that tariffs and taxes on output and depreciation are 0.

What are the ranges of the AS curve and what does each range represents?

There are 3 ranges of the a AS curve:

• horizontal or Keynesian section - shows that as aggregate demand goes up there is no increase in the price level but only output goes up

• intermediate section - upward sloping, we are nearing full employment and both employment and the price level increase

• vertical section - also called the Classical section, we are at full employment and increases in aggregate demand only increases the price level

In regard to aggregate demand, what is an expansionary policy? When would it be used?

An expansionary policy is one which shifts the aggregate demand curve to the right to increase employment and output. 

It would be used in times of a recession.

What are the tools used for implementing an expansionary policy?

The tools consist of fiscal policy and monetary policy.

In regard to fiscal policy, it would call for either or both a decrease in taxes or an increase in government expenditures.

In regard to monetary policy, it consists of an increase in the supply of money. This is oftentimes called an easy money policy.

What is a contractionary policy and when would it be used?

A contractionary policy would be an attempt to shift the aggregate demand curve to the left and it would be used during times of inflation.

What are the tools for implementing a contractionary policy?

The tools consist of both fiscal policy and monetary policy.

In regard to fiscal policy, it would consist of either or both raising taxes or cutting government expenditures.

In regard to monetary policy, it consists of a decrease in the supply of money. This is oftentimes called a tight money policy.

describe stagflation

Stagflation is the simultaneous occurrence of both recession and inflation.

It is a result of the aggregate supply curve shifting leftward. As the price level goes up, output or employment goes down. There is both stagnation and inflation.

Why is expansionary AD policy ineffective in dealing with stagflation?

It is ineffective because if we have an expansionary policy and the AD curve shifts to the right the amount of inflation will actually get worse.

If we enact a contractionary policy, the aggregate demand curve will shift to the left and it will worsen the amount of unemployment.

What is supply-side economics?

Supply-side economics refers to a school of thought in economics that believes that we should want to make the aggregate supply curve  shift rightward.

It emphasizes minimizing the cost of production. Therefore, for instance, it would like to lower the amount of government regulations on business. It also focuses on increasing incentives so people will work longer and harder. For example, supply-siders argue for tax cuts in order to increase incentives.

Who was John Maynard Keynes?

• Influential 20th-century economist who wrote The General Theory (1936) during the Great Depression

• He argued for active government intervention and expansionary policies to boost the economy

• His popularity declined in the 1970s due to stagflation, but revived during the 2007–2009 Great Recession as economists returned to his ideas.

Who was Milton Friedman?

• Leading 20th-century economist known for promoting the link between liberty and capitalism

• A key monetarist, he argued that monetary policy is powerful but that the money supply should grow steadily, not be changed drastically

• In A Monetary History of the United States (with Anna Schwartz), he claimed the Federal Reserve caused the Great Depression — a view later acknowledged by Fed chair Ben Bernanke.