Understanding Aggregate Demand and Supply

These flashcards cover key concepts related to aggregate demand, aggregate supply, and their interactions within the economy, particularly in the context of recent economic events.

What is aggregate demand (AD)?

Aggregate demand (AD) is all spending in an economy for different values of the price level (P), expressed as AD = C + I + G + NX.

What are the components of aggregate demand (AD)?

The components of aggregate demand are Consumption (C), Investment (I), Government Purchases (G), and Net Exports (NX).

What does the acronym AD = C + I + G + NX represent?

It represents the equation for aggregate demand where AD stands for aggregate demand, C for consumption, I for investment, G for government spending, and NX for net exports.

What effect does increasing government purchases (G) have on aggregate demand?

Increasing government purchases shifts the aggregate demand curve to the right, signaling more total spending in the economy.

What does it mean when the price level (P) increases according to the aggregate demand and supply model?

An increase in the price level (P) generally leads to a decrease in real wealth, which can reduce consumption (C) and therefore decrease aggregate demand (AD).

What causes total spending in the economy to grow?

Total spending grows due to factors such as increased consumer confidence, lower interest rates, increased government spending, and rising foreign income.

What is short-run aggregate supply (SRAS)?

Short-run aggregate supply (SRAS) refers to the total production of goods and services in an economy at various price levels, where some input costs are fixed.

What happens to production (Y) in the short run if costs rise faster than prices?

If costs rise faster than prices, production (Y) will fall as businesses cut back on output due to increasing expenses.

What is Okun's Law?

Okun's Law states that for every 1% decrease in the unemployment rate, a country's GDP will be an additional roughly 2% higher.

How do interest rates affect consumption (C)?

Lower interest rates typically increase consumption (C) because they reduce the cost of borrowing, allowing consumers to spend more.

What effect do tariffs have on aggregate demand?

Tariffs can lead to decreased consumption and investment (C and I), which may lower aggregate demand overall or complicate its effects.

What did the CARES Act and ARPA of 2021 aim to achieve?

Both laws aimed to provide fiscal stimulus during the Covid recession to support incomes, increase consumer spending, and boost aggregate demand.

What influences the shape of the aggregate demand curve?

Factors like consumer spending, investment activity, government policies, net exports, and interest rates influence the shape of the aggregate demand curve.

What relationship exists between short-run aggregate supply and inflation?

An increase in aggregate demand can lead to inflation if it outweighs the economy’s capacity to supply goods and services, resulting in higher price levels.

What does SRAS shifting to the left indicate?

A leftward shift in SRAS indicates a decrease in aggregate supply due to higher production costs, potentially leading to inflation.

How did the Fed respond to the Covid recession?

The Fed cut interest rates to near zero and engaged in quantitative easing by buying large amounts of bonds to stimulate credit and encourage spending.

What are the key factors determining the equilibrium in the aggregate demand and supply framework?

Equilibrium is determined by the intersection of the aggregate demand (AD) and short-run aggregate supply (SRAS) curves, affecting the levels of prices (P) and real GDP (Y).