Exam 3: Aggregate Demand and Supply

Aggregate Demand (AD)

A schedule or curve that represents the relationship between the quantity of real GDP demanded in the economy and the price level, all else held constant

Quantity of Real GDP Demanded

The aggregate quantity of output (real GDP) demanded at a given price level. Sometimes referred to simply as output

Aggregate Expenditures (AE)

The sum of all expenditures made in an economy on consumption, gross investment, government purchases, and net exports. In equilibrium, aggregate expenditures equal income, or real GDP

Aggregate expenditures equilibrium identity (Equilibrium line)

AE = Y

Autonomous Consumption (A)

The level of consumption expenditure when income is equal to zero. Autonomous consumption is funded by drawing on savings or by borrowing

Real-balances effect

One of the three reasons that aggregate demand is downward-sloping: When the price rises, the real value of savings falls and people are less willing or able to buy goods and services, thus reducing the aggregate quantity of real GDP demanded

Interest- Rate Effect

One of the three reasons that aggregate demand is downward-sloping; When the price level rises, the demand for money increases, which causes interest rates to rise, resulting in a decrease in investment and consumption spending, thus reducing the aggregate quantity of real GDP demanded

Foreign- Purchases Effect

One of the three reasons that aggregate demand is downward-sloping: when the price level rises, the quantity of exports decreases and the quantity of imports increases, resulting in a decrease in net exports, this reducing the aggregate quantity of real GDP demanded

Diminishing Marginal Utility

The negative relationship between the quantity of a good, service, or resource, and the marginal utility obtained from each additional unit consumed in a given period of time

Income Effect

1. The effect that a change in the price of a good, service, or resource has on the purchasing power of income.

2. For example, when price decreases, the purchasing power of income increases and consumers are able to purchase more goods and services and resources.

The Substitution Effect

The effect that a change in the price of one goods, service, or resource, has on the demand for another.

Consumption

All expenditures made by households on goods and services, like clothing, food, electronics, and recreation, during a given time period

Gross Investment (I)

The dollar value of new capital purchased (as investment) and the expansion of inventories in an economy during a given time period. Gross investment is classified into three categories; business fixed investment, residential investment, and inventory investment.

gross investment is also referred to as

"investment"

Increase in Aggregate Demand

An increase in the quantity of real GDP demanded in the economy at every price level

The change of an increase in AD graphically

Represented by a rightward shift of the aggregate demand curve

Decrease in Aggregate Demand

A decrease in the quantity of the real GDP demanded in the economy at every price level

The change of a decrease in AD graphically

leftward shift on the aggregate demand curve

Exchange rate

The rate, or price, at which one currency can be exchanged for another

Appreciation (of currency)

An increase in the value, or price, of one currency relative to another

Depreciation (of currency)

A decrease in the value, or price, of one currency relative to another

Government Purchases (G)

All final goods purchased by federal, state, and local governments - such as tanks, police cars, fire engines, and office supplies - during a given time period, as well as all final services purchased from labor resources - such as airport security personnel, police officers, and teachers

Net Exports (NX)

The difference between exports and imports

Aggregate Supply (AS)

A schedule or curve that represents the relationship between the quantity of real GDP supplied in the economy and the price level

Another name for aggregate supply

"short-run aggregate supply"

Sticky Wages

a situation where wages do not adjust in the short run. If wages are sticky downward, workers are reluctant to accept a decrease in their wages, creating a flat labor supply curve at the current wage

Productivity

The total amount of output produced with a given level of inputs. For labor, it is the average amount of output produced per worker in a specific time period

Increase in Aggregate supply

An increase in the quantity of real GDP supplied in the economy at every price level; graphically, it is represented by a rightward shift of the AS curve

Decrease in aggregate supply

A decrease in the quantity of real GDP supplied in the economy at every price level; graphically, a decrease in aggregate supply is represented by a leftward shift of the aggregate supply curve

Resource price

The price paid for, or opportunity cost of, using a resource such as land, labor, capital, or entrepreneurial ability

Social institution

The formal and informal "rule of the game" that society created to provide structure to political, economic, and social interactions

Long-run Aggregate Supply (LRAS)

The relationship between real GDP and the price level when all input prices are flexible. It is represented graphically as a vertical line at the full-employment level of real GDP, Y

Full-employment Real GDP

the level of real GDP produced in an economy when it is operating at the natural rate of unemployment. Also, the level of real GDP when the economy is in a long-run equilibrium.

Sticky Resource Prices

The idea that resource prices tend to adjust slowly in response to changes in the market

Flexible prices

The idea that, in the long run, resource prices are able to fully adjust to changes in the market

Long Run

the time period in which all inputs can be varied

Short run

the time period in which at least one input of production is fixed, but other inputs can be changed

Short-run equilibrium

A short-run situation in which the aggregate quantity of real GDP demanded is equal to the aggregate quantity of real GDP supplied

Where does the short run equilibrium occur graphically?

This occurs where the aggregate demand and aggregate supply curves intersect

Long-run Equilibrium

A market condition in which firms do not face incentives to enter or exit the market and firms earn a normal profit. Generally, it occurs when the market price is equal to the minimum average total cost faced by firms

Recession

A decline in real output for at least two consecutive quarters

Expansion

A phase of the business cycle characterized by increasing real GDP, income, and employment

Negative Shock to Aggregate Demand

A change to one of the determinants of aggregate demand that causes a decrease in the aggregate quantity of real GDP demanded at every price level

Graphical representation of a negative shock to aggregate demand?

Represented by a leftward shift of the aggregate demand curve

Positive Shock to Aggregate Supply

A change to one of the determinants of aggregate supply that causes an increase in the aggregate quantity of real GDP supplied at every price level

Graphical representation of a positive shock to aggregate supply

represented by a rightward shift of the aggregate supply curve

Demand-Pull Inflation

Inflation that occurs due to increase in aggregate demand

Cost-Push inflation

Inflation that occurs due to a decrease in aggregate supply

When do we use demand v. aggregate demand

We use demand to talk about price and quantity of a single good or service produced in a specific market. We use aggregate demand to describe the overall, or total, demand for all final goods and services produced in an economy

What is included in aggregate demand?

Includes the demand for goods and services as diverse as food, clothing, cars, health care, entertainment, and housing.

Where is the equilibrium of real GDP found at?

At the intersection of the aggregate expenditures schedule and the equilibrium line

What do we assume about the AD curve?

That the only thing that is changing as we move up and down the curve is the overall price level

How would a decrease in investment affect the aggregate Expenditure and Aggregate demand graphically

1. AE shift downward

2. Shift AD to the left

Effect of price decrease on AE and AD

In deriving the aggregate demand curve from the aggregate expenditures model, a shift of the aggregate expenditures schedule upward so that the new equilibrium GDP is lower than before the price level change

what can be described with a decrease in net exports?

Price level increasing, causing a movement along the aggregate demand curve

What is the substitution effect similar to?

the foreign-purchases effect for the aggregate demand

Movement along the AD curve is caused by?

changes in price level

what term is used to indicate an increase in the purchasing power of the U.S. dollar relative to other currencies

Appreciation of the U.S. dollar

What could result in a rightward shift of the aggregate demand curve?

1. An increase in consumption spending

2. An increase in investment

3. an increase in net exports

4. An increase in foreign income

What are the effects of changes in U.S. incomes?

Higher incomes will Increase U.S. imports and Decrease net exports

How will the AD curve be affected if net exports are increasing because of the lower price level

there will be a movement along the AD curve

Government Expenditures

payments made by the government for final goods and services and transfer payments

Why is the supply curve for an individual good or service is upward-sloping?

Marginal cost are increasing

Why does the aggregate supply curve slope upwards in the short run?

Because input prices are sticky and take time to adjust

Why is the long-run aggregate supply curve is a vertical line

because input prices are flexible in the long run

What must happen for the economy to be in its long run equilibrium?

the short-run aggregate supply and aggregate demand curves must interact at the full employment level of output

Where does the short run equilibrium occur graphically?

Where SRAS and AD intersect

Where does the long-run equilibrium occur graphically?

The AD, AS, and LRAS curves intersect

What kind of events can shift the aggregate supply curve and aggregate demand curve?

Natural disasters

Government policies

What will happen if the aggregate demand shifts in the short run?

Aggregate supply will eventually shift in the long run to bring the economy back to full employment

What is true about the nominal or money wages

Wages tend to be stickier moving upward then downward