Aggregate Demand and Aggregate Supply Model

These flashcards cover key vocabulary and concepts related to the aggregate demand and aggregate supply model, economic fluctuations, and their implications for policy and the economy.

Aggregate Demand (AD)

The total amount of goods and services that all buyers (households, businesses, government, and foreign buyers) are willing and able to purchase at different price levels in an economy.

Aggregate Supply (AS)

The total amount of goods and services that all firms in an economy are willing and able to produce and sell at different price levels.

Short-Run Aggregate Supply (SRAS)

In the short run, a higher overall price level encourages firms to produce more goods and services, while a lower price level leads to less production. This relationship is typically shown as an upward-sloping curve because some input costs (like wages) are 'sticky' or slow to change.

Long-Run Aggregate Supply (LRAS)

In the long run, the economy's total output is determined by its resources (labor, capital, technology) and is not affected by the price level. This means the LRAS curve is a vertical line at the economy's natural rate of output, where all resources are fully employed.

Business Cycle

The natural ups and downs in economic activity over time, marked by periods of growth (expansion) and decline (contraction or recession).

Recession

A period when the economy is shrinking, marked by falling production (GDP), rising unemployment, and declining incomes.

Expansion

A period when the economy is growing, marked by increasing production (GDP), falling unemployment, and rising incomes.

Wealth Effect

When the overall price level falls, people's existing money and savings can buy more, making them feel wealthier and encouraging them to spend more. This is one reason why aggregate demand slopes downward.

Interest Rate Effect

When the overall price level falls, people need less money to buy goods and services. This reduces the demand for loans, pushing interest rates down, which then encourages businesses to invest more and consumers to borrow more for big purchases. This is another reason for the downward slope of aggregate demand.

Net Export Effect

When the domestic price level falls, domestic goods become cheaper compared to foreign goods. This leads to an increase in exports (foreigners buy more of our cheaper goods) and a decrease in imports (we buy less expensive foreign goods), thereby increasing net exports. This also contributes to the downward slope of aggregate demand.

Sticky Wages Theory

This theory explains why the short-run aggregate supply curve slopes upward. It suggests that wages are slow to adjust to changes in the overall price level due to contracts or reluctance from employers/employees to change pay. If prices rise but wages stay the same, firms find it more profitable to produce more.

Sticky Prices Theory

This theory also helps explain the upward-sloping short-run aggregate supply curve. It states that the prices of some goods and services are slow to change (e.g., due to 'menu costs' of changing price tags). When overall demand changes, firms with sticky prices may adjust their production levels rather than immediately changing prices, leading to a short-run output response.

Misperceptions Theory

This theory suggests that firms and workers might sometimes misunderstand changes in the overall price level. They might think changes in their specific prices or wages are unique, rather than part of a general economic trend, leading them to temporarily adjust their production or work efforts. This creates the upward slope of the short-run aggregate supply curve.

Stagflation

A difficult economic situation where there is slow economic growth (stagnation), high unemployment, and rising prices (inflation) all at the same time. It's often caused by a negative supply shock, like a sudden increase in the price of oil.

Demand Shock

An unexpected event that causes a sudden and significant change in the overall demand for goods and services in the economy. For example, a sudden surge in consumer confidence could be a positive demand shock, leading to more spending.

Supply Shock

An unexpected event that causes a sudden and significant change in the overall supply of goods and services in the economy. For example, a natural disaster destroying crops or a sudden increase in oil prices are negative supply shocks, which can reduce production and raise prices.