ECO 001 Lecture Notes - Lecture 6: Aggregate Demand, Government Spending, Price Level

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15 Jun 2018

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Lesson 6: AS/AD

Jadzia Wray

1.) The Aggregate Demand Curve – what is it? Why is it downslopping?

a. Aggregate – clumped, all together, overall

b. Wealth effect, price increases = people feel poor = don’t buy things =

curve shifts left. Price decreases = people feel rich = buy more things =

curve shifts right.

Price level

Output RGDP = quantity

2.) AD = C + I+ G + XN (same as GDP equation)

C - Consumption

I - Investment

G – Government spending

XN – Net Exports

GDP is the stuff we make and AD is the stuff we demand.

This means that the stuff we make equals the stuff we demand.

If GDP is greater than AD then there is a surplus and there is going to be a

recession.

If AD is greater than the GDP then there is a shortage and there is demand pull

inflation.

We want GDP to equal AD.

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3.) What can make the AD curve shift?

If any of these things go up then the AD will increase.

If any of these things go down then the AD will decrease.

a. Consumer Spending: steady – people don’t just stop buying things

i. Wealth – if the real value of household assets rises, AD shifts right.

If the real value of household assets falls, AD shifts left.

ii. Expectations – every month they do consumer expectation surveys.

When people are confident about the economy it improves because

they will spend more = curve shifts right.

iii. Indebtedness: people borrow money to spend it but at some point

they have to start paying it back and that hurts the economy

because that’s money the economy could’ve used to buy things.

When the gov gave money in 2001 and told people to spend it, they

did. But in 2010 if we got money, we would use it to pay bills.

When you borrow money, the curve shifts right because then you

have money to spend. When you return money, the curve shifts left

because then you are not spending the money.

iv. Taxes: when taxes go up, AD goes to the left. People will have

less money to spend. If you get a tax cut, AD goes to the right

because people have more money to spend.

b. Investment: the most variable – volatile (stuff that makes more stuff =

investment. Ex: factories, printer)

i. Real Interest Rate – like the most important thing ever!: when you

want to buy something big, you borrow the money. There’s an

opportunity cost. If you have 2 million dollars and spend it on one

thing, then you can’t use it again. You borrow the money, and then

invest in other things so you make more money and can pay it

back. Real interest rate – when you go to buy a house, they ask

what can you afford? Like how much do you want your monthly

payments to be? The greater the interest - the greater your

monthly payments. The cheaper the interest rate – the less your

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Document Summary

Why is it downslopping: aggregate clumped, all together, overall, wealth effect, price increases = people feel poor = don"t buy things = curve shifts left. Price decreases = people feel rich = buy more things = curve shifts right. Ad = c + i+ g + xn (same as gdp equation) Gdp is the stuff we make and ad is the stuff we demand. This means that the stuff we make equals the stuff we demand. If gdp is greater than ad then there is a surplus and there is going to be a recession. If ad is greater than the gdp then there is a shortage and there is demand pull inflation. If any of these things go up then the ad will increase. If any of these things go down then the ad will decrease: consumer spending: steady people don"t just stop buying things, wealth if the real value of household assets rises, ad shifts right.

Related Questions

1. Which of the following shifts aggregate demand to the right?
a. Congress reduces purchases of new weapons systems.
b. US exports increase.
c. The price level falls
d. New developments in IT increase the productivity of most manufacturing industries in the US.

2. Suppose the EPA introduces new smog regulation that makes it costlier to produce cars. As a result, aggregate supply falls (primary effect) and firms cut back on production. With less output in the economy available for consumers, consumers bid up the prices of available output. With higher prices, firms choose to produce more (secondary effect).
Which of the following best explains what the net effect on GDP?
a. The two effects should essentially cancel out, with little to no effect on GDP, but the price level clearly rises.
b. It is impossible to say what happens to GDP without being able to compare the magnitudes of the two effects.
c. Real GDP rises as the secondary effect dominates the primary effect.
d. Real GDP falls since the primary effect dominates the secondary effect.

3. A Keynesian economist who observes an output gap would conclude that
a. aggregate demand should be shifted to the right.
b. a policy of deregulation would be better than demand management policy
c. aggregate supply should be shifted to the right
d. All proposed answer options are correct

4. Monetarists believe
a. the Aggregate Supply curve is upward-sloping (but not vertical) over all time frames.
b. the Aggregate Supply curve can be treated as horizontal in the long run (over 10 years
c. the Aggregate Supply curve is vertical only in the very long run (over 20 years).
d. the Aggregate Supply curve can be treated as vertical in the short-to-medium run (1-2 years)

5. Suppose the price of oil increases due to conflict in the Middle East. How will this be illustrated in the AD-AS model?
a. The aggregate demand curve will shift to the left
b. The aggregate supply curve will shift to the left.
c. The aggregate demand curve will shift to the right
d. The aggregate supply curve will shift to the right

6. Assume a Keynesian AS curve. In the short run, when there is a large output gap
a. contractionary demand management policy is likely to be highly inflationary
b. expansionary demand management policy does not cause much inflation.
c. expansionary demand management policy is likely to be highly inflationary
d. the government should use contractionary demand management policy

7. As a result of Bush tax cuts that partially expired in January 2013, the marginal tax rates for some households increased and these households paid higher taxes. Which of the following would be the best description of the tax cut expiration?
a. Rightward shift in AS
b. Rightward shift in AD
c. Leftward shift in AD
d. Leftward shift in AS

8. Suppose that the U.S. government increases income taxes on individuals earning more than $500,000/year and uses the revenue from this tax increase to subsidize the cost of energy for businesses. How will this policy change affect the U.S. economy?
a. The effect on output is ambiguous but price level will decrease for sure
b. The effect on both output and price level is ambiguous.
c. The effect on price level is ambiguous but output will increase for sure
d. The effect on price level is ambiguous but output will decrease for sure

9. If Australia, which imports goods from the United States, went into recession, we would expect that U.S. net exports would
a. rise, making aggregate demand shift right.
b. rise, making aggregate demand shift left
c. fall, making aggregate demand shift left
d. fall, making aggregate demand shift right

10. Suppose that Greece decides to exit the European Union and the Euro Zone, causing a boost in business confidence in European markets. How would you illustrate the primary effect of Greeceâs decision in the AD-AS model for the EU economy?

Note: for this question, assume that Y in the AD-AS model represents output (GDP) of EU member countries without Greece.
a. a shift in the aggregate supply curve to the left and a shift in the aggregate demand curve to the left
b. a shift in the aggregate demand curve to the right
c. a shift in the aggregate demand curve to the left
d. movement along the aggregate demand curve to the left

11. The Austrian school of thought believes that demand management policy should not be used because
a. big government prefers deregulation, which shifts aggregate supply
b. the economy is always at full employment
c. shifting AD to the right is likely to cause deflation
d. big government has a bias towards inflationary policy

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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*

6. To study the macroeconomy we must combined prices and quantities generated in single-product markets into broad aggregates.

a)	True
b)	False

7. An economist who favored expanded government would recommend:

a)	tax cuts during recession and tax increases during inflation
b)	tax increases during recession and tax cuts during inflation.
c)	tax cuts during both recession and inflation
d)	increases in government spending during a recession and tax increases during inflation.
e)	tax cuts during recessions and reduction in government spending during inflation.

8. If Government tax revenue exceeds Government spending the result of the budget is

a)	an increase in investment
b)	a shortage
c)	an increase in the deficit
d)	a decrease in savings
e)	a surplus

9. Which of the following statements is true?

a)	In the US economy, the net export sector is positive.
b)	Aggregate demand is the sum of total output produced by all firms in the US.
c)	The aggregate supply curve is vertical if the price level is equal to the per-unit cost of production
d)	Aggregate production sums up the four major components C+I+G+Xn in the US economy.
e)	Government spending is the largest component of aggregate demand.

10. Which of the following statements is true?

	a) When unemployment is rising then real GDP is rising.
b)	The required reserve ratio is a tool used by the government to control the demand for money.
c)	The four components of aggregate supply are the same as aggregate demand.
d)	when an imported resource such as oil has decreased that is an increase in aggregate demand.
e)	The four components of aggregate demand---Households, Business, Government, and Net Exports.

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ECO 001 Lecture Notes - Lecture 6: Aggregate Demand, Government Spending, Price Level

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