Aggregate Demand and Agreggate Supply

What is a recession?

A period of falling real incomes and rising unemployment.

What are economic fluctuations characterized by?

They are irregular and unpredictable.

What happens to macroeconomic variables during economic downturns?

Most macroeconomic quantities fluctuate together.

What relationship exists between output and unemployment?

As output falls, unemployment rises.

What does the Classical Dichotomy separate?

Variables into real (quantities, relative prices) and nominal (money-measured) groups.

What does the neutrality of money state?

Changes in the money supply affect nominal but not real variables.

In the short run, how can changes in nominal variables affect real variables?

For example, changes in the price level (P) can affect real output (Y) and unemployment (u-rate).

What does the AD curve show?

The quantity of all goods and services demanded in the economy at any given price level.

What are the three reasons the AD curve slopes downward?

The wealth effect, the interest-rate effect, and the exchange-rate effect.

What is the wealth effect?

A decrease in the price level increases real wealth, leading to more consumer spending (C ↑).

What is the interest-rate effect?

A lower price level reduces interest rates, increasing investment spending (I ↑).

What is the exchange-rate effect?

A lower U.S. price level causes the dollar to depreciate, increasing net exports (NX ↑)

What shifts the AD curve?

Changes in C, I, G, or NX—not changes in P.

Why is the LRAS curve vertical?

Because the natural rate of output (Y_N) is determined by resources and technology, not the price level.

What causes the LRAS curve to shift?

Changes in labor, capital, human capital, natural resources, or technology.

Why is the SRAS curve upward sloping?

Due to sticky wages, sticky prices, and misperceptions in the short run.

What is the sticky-wage theory?

Nominal wages are slow to adjust, so higher-than-expected prices raise profits and output.

What is the sticky-price theory?

Due to menu costs, some firms can't quickly change prices, leading to lower relative prices and higher demand.

What is the misperceptions theory?

Firms mistake general price level increases for increases in their own relative prices, so they produce more.

What equation summarizes the short-run AS theories?

Y = Y_N + a(P – P_E), where a > 0 and P_E is expected price level.