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Chapter 14&15

Economics - Chapter 14&15 Notes.docx

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Bridget O' Shaughnessy

CHAPTER FOURTEENAGGREGATE DEMAND AND AGGREGATE SUPPLYThree Key Facts about Economic FluctuationsRecession a period of declining real incomes and rising unemploymentDepression severe recessionFact 1 Economic Fluctuations Are Irregular and UnpredictableFluctuations in economy called business cycleEconomic fluctuations hard to predictReal GDP grows rapidly business is good firms have nay customers profits growingReal GDP falls businesses have trouble economic contraction declining sales and profitsFact 2 Most Macroeconomic Quantities Fluctuate TogetherReal GDP measures o Value of all final goodsservices produced within given period of time o Total income of everyone in economyWhen real GDP falls so does o Personal income o Corporate profits o Consumer spending o Investment spending o Industrial production o Retail sales home sales auto salesMacroeconomic variables fluctuate togetherFluctuate by different amountsFact 3 As Output Falls Unemployment RisesReal GDP declines rate of unemployment risesFirms produce less so need less workersUnemployment never approaches zeroFluctuates around natural rateExplaining ShortRun Economic Fluctuations The Assumptions of Classical EconomicsPerfect capital mobility real interest rate in Canada must increasedecrease with increasesdecreases in value of world real interest rateClassical dichotomy separation of real variables and nominal variablesReal variables measure quantities or relative pricesNominal variables measure in terms of moneyChanges in money supply affect nominal variables not real variablesMonetary neutrality determinants of real variables o Real GDP o Real interest rate o UnemploymentReal variables are more significant than nominal variablesIf money doubles everything would stay the same relative to each otherThe Reality of ShortRun FluctuationsClassical theory describes world in the long run but not in short run o Changes in money supply would affect prices nominal variables o Would not affect real GDP unemployment real variablesShort run real and nominal variables would both changeFocus on how real and nominal variables interactThe Model of Aggregate Demand and Aggregate SupplyFirst variable economys output of goodsservices GDPSecond variable overall rice level CPI or GDP deflatorModel of aggregate demand and supply model used to explain shortrun fluctuations in economic activity around its longrun trendAggregatedemand curve shows quantity of goodsservices that households firms and government want to buy at each price levelAggregatesupply curve quantity of goodsservices that firms choose to producesell at each price levelThe AggregateDemand CurveSlopes downwardFall in economys overall level of prices raises quantity of goodsservices demandedIncrease in price level reduces quantity of goodsservices demandedWhy the AggregateDemand Curve Slopes DownwardGDP YCIGNXGovernment spending is fixed by policyC I NX depend on economic conditions and price levelThe Price Level and Consumption The Wealth EffectNominal value of money is fixedReal value of money not fixedDecrease in price level o Makes consumers wealthier o Encourage them to spend o Larger quantity of goodsservices demandedIncrease in price level o Reduces real value of money o Reduce wealth consumer spending quantity of goodsservices demanded
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