Declining real income+rising unemployment (2 quarters in a row)
What is depression?
Are fluctuations irregular?
yes, and unpredictable.
What changes in other variables do fluctuations correspond with?
profit, number of customers, sales revenue
When GDP decreases what happens to unemployment?
unemployment decreases. It fluctuates around a national rate of 6%
True or False: Most economists believe that money neutrality is true in the long run but not the short run
True. Change in money supply results in change in real GDP after 3-5 years but not after 1-2 years
What does the AD curve show?
the quantity of goods and services that household firms demand, or government demand at each price level (AD=C+I+G+NX)
What does the AS curve show?
The quantity of goods and services that firms choose to produce and sell at each price level
The AD curve slopes downward or upward?
What is the wealth effect?
When the price level decreases, the value of money increases, consumption increases, people feel wealthier
What is the interest rate effect?
When the price level decreases, the quantity of money demanded increases, cash decreases, savings increase, real interest rate decreases, investment increases
What is the exchange rate effect?
When the price level decreases, real interest rate decreases, NCO decreases, Supply of $ increases, real nominal exchange decreases, Quantity of money demanded increases
What are the factors other than price level that change when the AD curve shifts?
-When consumption increases, AD Shifts right
-When investment increases, AD shifts right
3. Government spending
-When government spending increases, AD shifts right
4. Net exports
-When net exports increase, AD shifts right
Why is LRAS vertical?
-money neutrality: change in price level means no change in quantity
-In long run production of goods and services is determined by supply of resources, production, tech
Why does LRAS shift?
-position of LRAS occurs at "potential output" or "full employment output"
-National rate of output
National Rate of Output (why LRAS shifts)
production of goods and services that economy achieves in LR with unemployment at national rate
LRAS is affected by Labor, Capital, Natural Resources, and Technology
Why does SRAS slope up?
-Money neutrality does not hold here
-Price level increases, the quantity supplied in SR increases
What is the sticky wage theory?
When prices increase, wages are fixed in the short run because of long term contracts between workers and firms, and social norms and notions of fairness
What is sticky price theory?
Price of some goods and services are slower to respond than others (menu costs) to price level changes. When prices falls unexpectedly/suddenly firm does not change price of the product, then relative price increases, demand decreases, and quantity supplied decreases
What is the misperceptions theory?
unexpected change in overall price level can mislead/confuse suppliers. They don't know what is happening in markets where they sell products. Unexpected decrease in price of a product or relative price of a product signals preferences and quantity supplied decreases because they assume demand is low for their product
What is the equation for quantity of output
Nat'l rate of output + (Actual Price level-Expected price level)
Why does SRAS shift?
1. Same as LRAS (L,K,T,NR)
2. Expected Price level (increase--> expected wage increase) SRAS shifts left because firms cost increases as negotiate increase in wage in LR
What is the government's policy when AD decreases?
1. Do nothing: wait for LR even things out
2. Intervene: Government increases spending to create jobs or increases money supply
-Production of goods and services increased
-Money supply decreased
-r increased, Investment decreases, AD decreases
a. Housing boom post 2001 r decreased price of mortgage, investment increased, home purchase increased
b. subprime boomers
c. securitization (bundling and trading mortgages)
d. 06-09 house demand decrease
e. Bank losses on securities: value loans decreased
unemployment very high, workers lose bargaining power
AD curves slopes down
1. wealth effect
2. Interest effect
3. exchange rate effect
AD shifts due to money supply change
Fiscal Policy on AD
setting of G, T by congress, president, policymakers
more direct than monetary policy
Multiplier Effect (Fiscal)
Increased government spending, multiplier effect leads to increase in consumption, increase in investment, AD increases
Marginal Prosperity to Consume (MPC)
Fraction of extra income that a household consumes rather than saves
Change in C=MPCxChange in income
change in AD=1/1-MPC x initial change
Crowding out effect
AD decreases, offset in AD resulting from government increase which increases interest rate, investment decreases
When the multiplier>crowding out
change in AD>change in government spending
When multiplier<Crowding out
change in AD< change in government spending
Case for active stabilization (Keynes)
1. Increase in government spending, increase in price level in SR, inflation
2. Simultaneously decrease AD with monetary policy MS decreases, interest rate increases, investment decreases
3. Return to original AD curve
Case against stabilization (Hayek)
A. Measure P, Q to establish where AD is, complicated
B. Lags (things take a long time, changes occur during that time)
C. Automatic Stabilizers
What are automatic stabilizers?
a. Tax system: in a recession incomes decrease, profits decrease, personal income tax decreases (T goes up, C goes up, AD goes up)
b. Government spending: transfer payments (G goes up, AD goes up)
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