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01:220:103 Lecture Notes - Lecture 16: Potential Output, Price Level, Interest Rate

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limeherring262
4 Apr 2017
School
Rutgers University
Department
Economic
Course
01:220:103
Professor
Barbara Crockett

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Document Summary

Total supply of all goods and services in an economy. A graph that shows the relationship between the aggregate quantity of output supplied by all firms in an economy and the overall price level. In the short run, (as) has a positive slope (price/output response curve) At low levels of aggregate output, curve is flat. As the economy approaches capacity, the curve becomes nearly vertical. The effects of a change in the interest rate. A high interest rate (r) discourages planned investment (i) Planned aggregate expenditure (ae) at everly level of income falls. A decrease in ae lowers the equilibrium output (income) (y) by a multiple of the initial decrease in i. Relationship between aggregate output and the interest rate in the goods market. An increase in government spending (g) with the interest rate fixed increases output (y), which shifts the is curve right. Output (y) and inflation (p) are two main inputs into the fed"s interest rate decision.

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Related Questions

Suppose that the Australian economy is at long run equilibrium, and the Australian government announces its decision to decrease spending on infrastructure.

Discuss the short-run effects of a decrease in spending on aggregate espenditure (AE) and aggregate demand (AD). in your discussion, explain the process that moves the economy to its new equilibrium output. That is, explain what would happen to:

1. aggregate planned expenditure

2. firms inventories and production

3. disposable income and consumption expenditure

4. aggregate demand and supply

5. real GDP and price level

Use the AE and AD Graph for your graphical analysis to support your explanation.

a) 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
b) 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
c) 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
d) 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
e) 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
f) 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
g) 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
h) 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
i) 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
j) 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*

A typical AS curve has three parts: a flat, horizontal portion at low levels of output, a middle section with a more-or-less gentle upward slope, and a steep or vertical portion at high levels of output. Let's consider two of these parts individually, the horizontal portion and the vertical portion.

A. Imagine that AS and AD intersect in the horizontal portion of the AS curve. In this case, if aggregate demand increases, how does the output of the economy change? Does demand drive the economy here? (5 points)

B. Imagine that AS and AD intersect in the vertical portion of the AS curve. In this case, if aggregate demand increases, how does the output of the economy change? Does demand drive the economy here? (5 points)

C. Imagine that AS and AD intersect in the vertical portion of the AS curve. Assume a technological breakthrough increases the full-employment level of RGDP and shifts the AS curve to the right. In this case, when aggregate supply increases, how does the output of the economy change? Does supply create its own demand? (5 points)