ECN 204 Lecture Notes - Lecture 6: Aggregate Demand, Indirect Tax, Quid Pro Quo

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15 Nov 2015

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Aggregate demand (ad): overall demand for all goods and services at various price levels: household demand (c, business (i, government (g, foreigners (x-m) Why is ad curve a downward slope: wealth effect if price level increase, real income decrease people fee; relatively poorer ad decrease. Interest rate effect if price level increase, interest rate increase ad decrease: trade effect if price level increase, exports go down, imports increase ad. Things that will increase the graph upwards to the right (outwards) Things that will decrease the graph downwards to the left (inwards) decrease. Factors: future expectations, fiscal policy, monetary policy, exchange rate. Test options: upward movement, downward, outward d. Aggregated supply (as): overall availability at various price levels. As curve is upward slope and becomes steeper and steeper as resources are used up. Other factors affecting as: availability of resources (+, cost of resources (-, productivity of resources (+, technology (+, weather/nature (-, future expectations (+, taxes & government regulations (-)

Related Questions

1. Explain how the real balance effect works?

2. How will either the AD curve or SRAS curve shift as a result of each of the following changes:

A rise in the interest rate

An adverse supply shock

A rise in wealth

3. Explain what happens to U.S. net exports and U.S. aggregate demand as the dollar depreciates

4. Explain what happens to aggregate demand in each of the following cases: (a) The interest rate rises; (b) Wealth falls; (c) The dollar depreciates relative to foreign currencies; (d) Households expect lower prices in the future; (e) Business taxes rise.

5. Explain how expectations about future sales will affect investment.

6. Explain how each of the following can affect short-run aggregate supply: (a) An increase in wage rates; (b) A beneficial supply shock; (c) An increase in the productivity of labor; (d) A decrease in the price of a nonlabor resource (such as oil).

(a) An increase in SRAS that is greater than the increase in AD will lead to an increase in Real GDP and a fall in the price level.

(b) A decrease in AD that is greater than the increase in SRAS will lead to a fall in both the Real GDP and the price level.

roseshark361

In the AD-AS model, stagflation does not persist, because the working of the self-correcting mechanism of the economy _____ the level of output and _____ the price level until the economy eventually returns to a long-run equilibrium state, where actual output _____ potential output.

	decreases; decreases; falls short of
	increases; decreases; equals
	decreases; increases; exceeds
	decreases; increases; equals
	increases; decreases; exceeds

The LRAS curve is drawn as a vertical line at potential output (Y*) to indicate that

	Y* is independent of the price level and that actual output Y > Y* in the long run
	Y* equals actual output (Y) in the long run
	Y* is independent of the price level and that actual output Y = Y* in the long run
	Y* is independent of the price level
	Y* is independent of the price level and that actual output Y < Y* in the long run

Stagflation arises in the context of the AD-AS model when some external factor causes

	the LRAS curve to shift to the right
	the AD curve to shift leftwards
	the SRAS curve to shift downwards
	the SRAS curve to shift upwards
	the AD curve to shift rightwards

If the SRAS curve is positively sloped, then a decrease in the demand for Canadian-made goods in Europe will lead to _____ in the price level, in the short run.

	either an increase or a decrease
	no change
	an increase
	a decrease
	an initial increase, and then a decrease

Which of the following will shift the aggregate demand curve to the right?

	Consumers become pessimistic about the future
	A new technology is developed that will increase profits
	Income taxes are raised
	Foreign economies fall into recession, reducing their demand for domestic exports
	The government reduces purchases to balance the budget

Suppose a stock market crash decreases the stock of household wealth and therefore causes autonomous consumption to fall. Which of the following is the likely result?

	A leftward shift the AD curve
	There will be no movement of the AD curve
	A movement down the AD curve
	A movement up the AD curve
	A rightward of the shift the AD curve

An economy is characterized by the AD equation P = 200 ? 0.02Y, SRAS equation P = 100 and LRAS equation Y* = 5000. In the absence of any change in policy or exogenous shocks, this economy will achieve a long-run price level of

	100
	110
	120
	90
	105

The AD-AS model depicts a self-correcting economy. This means that the price level in the model adjusts automatically in response to a(n) _____ gap, so as to eliminate the _____ gap in the long run, without requiring any help from government policies.

	recessionary; recessionary
	recessionary; expansionary
	expansionary; expansionary
	output; output
	expansionary; recessionary

The aggregate demand curve shows

	the amount of planned aggregate expenditure (and output) at the current price level
	the amount of planned aggregate expenditure (and output) at an average price level
	the amount of planned aggregate expenditure (and output) at a constant price level
	the amount of planned aggregate expenditure (and output) at various price levels
	the amount of planned aggregate expenditure (and output) at last year's price level

Consider an economy initially at long-run equilibrium with output (Y) equal to potential output (Y*). If the SRAS is positively sloped, then a shift to the right of the AD curve will lead to _____ in the price level, in the short run. In the long run, the SRAS curve will shift to the _____ and the equilibrium will be at __________.

	an increase; left; Y = Y*
	a decrease; right; Y > Y*
	an increase; right; Y = Y*
	a decrease; left; Y > Y*
	no change; left; Y = Y*

MBA502, Economics for Business

Apply and Discover 7.2

You are responsible for economic policymaking in your country. Your desire is to eliminate inflation, keeping prices absolutely stable at P = 100, no matter what happens to output. Currently, the economy is in equilibrium at Q = 3200 (where Q = potential GDP) and P = 100. You can use monetary and fiscal policies to affect aggregate demand but you cannot affect aggregate supply in the short run. How would you respond to the following scenarios?

Explain and illustrate how each of these events would affect aggregate demand, aggregate supply, and prices, then explain how you would respond with economic policies.

1. A surprise increase in investment spending

In the short run, when investment spending increases, it results in an increase in Aggregate Demand (AD), which in turn pushes up both GPD and the price index.

To counterbalance this development, government might pursue contractionary fiscal policy by increasing taxes (to reduce consumption) or decreasing its own investment and spending so that the AD curve shifts back to its original position. Alternatively, the government can pursue contractionary monetary policy by reducing money supply and increasing interest rate to discourage economic activity.

2. Catastrophic floods that cause a sharp food price increase

In this case, sharp food shortages and consequent price increases cause a shock-type adjustment of the aggregate supply curve (it shift up and to the left). The result is a lower GDP and a higher price level.

The government cannot do anything to adjust AS in the short run. However, if the goal is to maintain the price level constant, the government can decide to do something to decrease the aggregate demand to force prices to come down, though it will be accompanies by another contraction in GDP and so it would not be a smart thing to do.

To cause AD to decrease, the government, similar to example above, can pursue fiscal policy (increase taxes, decrease spending) or monetary policy (reduce supply of money to the economy and thus increase interest rates).

3. A productivity decline that reduces potential output

In this case, AS shifts to the left, as was the case in example 2. As a result, price levels go up, as the same amount of money is chasing the reduced amount of goods and services, and GDP declines.

Government remedies here would be centered about causing AD to decrease through contractionary fiscal (higher taxes, lower spending) or monetary (reduce money supply and increase interest rates) policy. Again, this decision reduces inflation but at expense of GDP, as real output shrinks further.

4. A deep depression in East Asia that causes a sharp decrease in net exports to the United States

A decrease in exports of goods to from the United States to Asia will mean that the aggregate demand (which includes net exports

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ECN 204 Lecture Notes - Lecture 6: Aggregate Demand, Indirect Tax, Quid Pro Quo

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