Macroeconomics Unit 3: Aggregate Demand, Aggregate Supply, and Economic Fluctuations

Essential vocabulary flashcards covering Aggregate Demand, Aggregate Supply (SRAS and LRAS), Classical versus Keynesian perspectives, macroeconomic gaps, and business cycle fluctuations.

Recession

Two consecutive quarters of decline in real output (real GDP), typically accompanied by rising unemployment and decreasing real incomes.

Depression

A very severe and long-lasting recession where economic output plummets and unemployment stays exceptionally high.

The Great Depression

A historic economic collapse lasting from 1929 to 1939 where real GDP fell by $30\%$ and the unemployment rate peaked at $20\%$.

Business Cycle

The recurring fluctuations of economic activity over time, moving through phases of peak, recession, trough, depression, recovery, and expansion.

Aggregate

The total or the combined sum of many smaller individual economic parts.

Aggregate Demand (AD) Curve

A downward-sloping curve showing the total quantity of goods and services demanded by all sectors of the economy (households, businesses, governments, and foreigners) at each price level.

Real Interest Rate Effect

One reason the AD curve is downward sloping: a higher price level causes nominal interest rates to rise, discouraging borrowing and leading to reduced consumption and investment.

Income Effect (Aggregate Demand)

A reason the AD curve slopes downward: an increase in the price level erodes the real purchasing power of money, leading to a decrease in overall consumption.

Net Export Effect

A reason the AD curve slopes downward: higher domestic price levels make domestic goods relatively more expensive to foreigners, reducing exports and increasing imports.

Short Run

A period of time during which at least one cost of production is fixed and nominal wages or prices do not fully adjust to economic changes.

Long Run

A period of time long enough for all input prices, nominal wages, and fixed costs to become fully flexible and adjust to economic conditions.

Say's Law

The classical economic principle that 'supply creates demand'—producing goods generates an equivalent amount of income that is immediately used to buy products, summarized as 'products are paid for with products.'

Jean-Baptiste Say

A French economist (1767–1832) who formulated Say's Law and contributed fundamentally to classical economic thought.

Classical Economic Theory

An economic school of thought holding that wages and prices are flexible, aggregate demand is not an issue, resources are fully employed in the long run, and recessions naturally self-correct.

Long-Run Aggregate Supply (LRAS) Curve

A vertical aggregate supply curve positioned at potential full-employment GDP ($Y_F$), demonstrating that output in the long run depends on resources (land, labor, capital) and technology rather than the price level.

John Maynard Keynes

A British economist (1883–1946) who founded modern macroeconomics, wrote 'The General Theory of Employment, Interest, and Money', and argued that demand drives the economy because wages and prices are sticky in the short run.

Keynesian Theory

The macroeconomic perspective that aggregate demand drives the economy, equilibria can persist below full employment during recessions, and government policy intervention is required to stimulate demand.

Sticky Wage Theory

The theory that nominal wages are slow to adjust to changing price levels due to formal contracts and social norms, causing the short-run aggregate supply curve to be upward sloping.

Sticky Price Theory

The explanation of the upward-sloping SRAS stating that firms adjust prices slowly due to menu costs, causing output to drop when a falling price level makes their goods relatively too expensive.

Menu Costs

The tangible costs associated with changing advertised prices, such as the expense of printing new catalogs, creating new price tags, or updating menus.

Misperceptions Theory

A theory explaining the upward slope of SRAS wherein producers temporarily confuse a general decline in the overall price level with a drop in their own product's relative price, prompting them to cut production.

Short-Run Aggregate Supply (SRAS) Curve

An upward-sloping curve showing the total quantity of goods and services firms produce at each price level in the short run when prices and wages are sticky.

Stagflation

An adverse economic condition characterized by stagnant growth (falling GDP) combined with high inflation; historically referred to as the 'twin evils' and caused by negative supply shocks.

Recessionary Gap

A short-run macroeconomic condition where actual equilibrium output ($Y_C$) is below full-employment output ($Y_F$), and the actual unemployment rate ($U_R$) is greater than the natural rate of unemployment ($NRU$).

Inflationary Gap

A short-run macroeconomic condition where actual equilibrium output ($Y_C$) exceeds full-employment output ($Y_F$), and the actual unemployment rate ($U_R$) is below the natural rate of unemployment ($NRU$).

Demand Shock

A sudden and unexpected shift in the aggregate demand curve caused by unexpected changes in consumption ($C$), investment ($I$), government spending ($G$), or net exports ($NX$).

Supply Shock

A sudden event that dramatically alters the cost or availability of production inputs, shifting the short-run aggregate supply curve leftward (negative shock) or rightward (positive shock).