ECON 1100 Chapter 20: Chapter 20 Review notes

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Aggregate Demand and Aggregate Supply

● Recession: a period of declining real incomes and rising unemployment

● Depression: a severe recession

● Model of aggregate demand and aggregate supply

○ Used by economists to analyze short-run fluctuations

○ Aggregate demand curve & aggregate supply curve

I. Three Key Facts about Economic Fluctuations

A. Fact 1: Economic Fluctuations are Irregular and Unpredictable

1. The business cycle

a) Fluctuations in the economy

b) Economic fluctuations correspond to changes in business

conditions

c) Misleading because is suggests that economic conditions follow a

regular, predictable pattern

(1) In fact, economic fluctuations are almost impossible to

predict

B. Fact 2: Most Macroeconomic Quantities Fluctuate Together

1. Real GDP is the variable most commonly used to monitor short run

changes in economic activity

a) Measures the value of all final goods & services produced within a

given period of time

2. It turns out that most macroeconomic variables that measure some type

of income, spending, or production fluctuate closely together, so it doesn't

really matter which measure of economic activity one looks at

a) When real GDP falls into a recession, so does personal income,

corporate profits, consumer spending, investment spending,

industrial production, retail sales, home sales, auto sales, etc

b) Macroeconomic variables fluctuate together, but at different

amounts

C. Fact 3: As Output Falls, Unemployment Rises

1. When real GDP declines, the rate of unemployment rises

a) Change in the economy’s output of goods and services are

strongly correlated with changes in the economy’s utilization of its

labor force

II. Explaining Short-Run Economic Fluctuations

A. The Assumptions of Classical Economics

1. Classical dichotomy

a) Separation of variables into real variables (those that measure

quantities or relative prices) and nominal variables (those

measured in terms of money)

2. Monetary neutrality

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a) Changes in the money supply affect nominal variables but not real

variables.

b) As a result of this “monetary neutrality,” we are able to examine

real variables (real GDP, real interest rate, and unemployment)

without introducing nominal variables (the money supply and price

level)

3. “Money does not matter in a classical world,” “money is a veil:

a) Nominal variables may be the first things we see when we

observe an economy b/c economic variables are often expressed

in units of money

b) But what's really important are the real variables and economic

forces that determine them

c) Example: if money in the economy were to double, everything

would cost twice as much, and everyone’s income would be twice

as high

(1) The change would be nominal, and the things that people

really care about (weather they have a job, how many

goods and services they can afford) would be exactly the

same

B. The Reality of Short-Run fluctuations

1. Most economist believe that classical theory describes the world in the

long run but not in the short run.

a) AS classical theory describes: Changes in the money supply

affect prices and other nominal variables but do not affect real

GDP, unemployment, or other real variables

b) However, when studying year-to-year changes in the economy,

the assumption of monetary neutrality is no longer appropriate

2. In the short-run, real and nominal variables are highly intertwined

a) Changes in the money supply can temporarily push real GDP

away from its long-run trend

3. New model abandons classical dichotomy and the neutrality of money

a) No longer separates our analysis of real variables (output) from

our analysis of nominal variables (money and the price level)

b) New model focuses on how real and nominal variables interact

C. The Model of Aggregate Demand and Aggregate Supply

1. Model of short run economic fluctuations

a) Focuses on the behavior of two variables

(1) The economy’s output of goods & services, as measured

by real GDP

(2) The average level of prices, as measured by the CPI or the

GDP deflator

2. Model of Aggregate Demand and Aggregate Supply: the model that most

economists use to explain short run fluctuations in economic activity

around its long-run trend

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a) Aggregate-demand curve: a curve that shows the quantity of

goods and services that households, firms, the government, and

customers abroad want to buy at each price level

b) Aggregate-supply curve: a curve that shows the quantity of goods

and services that firms choose to produce and sell at each price

level

III. The Aggregate-Demand Curve

⇒ Tells us the quantity of all goods and services demanded in the economy at any given

price level

⇒ Other things being equal, a decrease in the economy’s overall level of prices

raises the quantity of goods and services demanded

⇒ Conversely, an increase in the price levels reduces the quantity of goods &

services demanded

A. Why the Aggregate-Demand Curve Slopes Downward

1. Why does a change in the price level move the quantity of goods and

services demanded in the opposite direction?

a) Recall: Y=C+I+G+NX

(1) Consumption (C)

(2) Investment (I)

(3) Government purchases (G)

(4) Net exports (NX)

(a) Each of these four components contributes to the

aggregate demand for goods and services

(b) Consumption, investment, and net exports depend

on economic conditions, and in particular, on the

price level

2. How the price level affects the quantity of goods and services demanded

for consumption, investment, and net-exports

a) Price Level and Consumption: The Wealth Effect

(1) Nominal value of money is fixed: One dollar is always

worth one dollar

(2) Real value of money is not fixed

(3) A decrease in the price level raises the real value of money

and makes consumers wealthier, which in turn encourages

them to spend more which means a larger quantity of

goods and services demanded

(4) An increase in the price level reduces the real value of

money, and makes consumers poorer, which in turn

reduces consumer spending and the quantity of goods and

services demanded

b) The Price Level and Investment: The Interest-Rate Effect

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Document Summary

Recession: a period of declining real incomes and rising unemployment. Model of aggregate demand and aggregate supply. Used by economists to analyze short-run fluctuations. Aggregate demand curve & aggregate supply curve. Tells us the quantity of all goods and services demanded in the economy at any given price level. Other things being equal, a decrease in the economy"s overall level of prices raises the quantity of goods and services demanded. A fall in the price level raises the overall quantity of goods & services demanded. Other factors affect the quantity of goods and services demanded at any given price level, and the aggregate-demand curve shifts. These factors include anything that has an effect on real gdp. Purchases aggregate demand curve shifts right: (cid:3451) in govt. Purchases aggregate demand curve shifts left: shifts arising from changes in net exports, (cid:3449) in net exports aggregate demand curve shifts right, (cid:3451) in net exports aggregate demand curve shifts left.

Related Questions

1. Fiscal policy attempts to affect the level of overall spendingin the economy by changes in:
A) the interest rate.
B) the money supply.
C) banking regulations.
D) taxes and spending.

2. Economists have identified several consecutive months of fallingemployment and forecasts for the next few months are for more ofthe same. At what point in the business cycle is the economyapparently located?
A) recession
B) expansion
C) business cycle peak
D) business cycle trough

3. The onset of the Great Depression:
A) was not a shock to anyone since most economists predicted theâroaring 20sâ were bound to end in disaster.
B) created a disagreement between the Hoover administration andconventional economists because Hoover wanted the government tointervene much more quickly than most others.
C) came as a considerable shock to the conventional wisdom ofeconomics at that time and opened the door for critiques ofmainstream thought by economists like JM Keynes.
D) was in 1918 at the end of World War I.

4. When economists measure economic growth, they often use:
A) the inflation rate.
B) the unemployment rate.
C) nominal GDP.
D) real GDP.

5. In a typical business cycle, the business cycle peak isimmediately followed by the:
A) recession.
B) business cycle trough.
C) expansion.
D) depression.

6. Suppose an economy experiences rising total output accompaniedby increasing employment, this is generally known as:
A) stagflation.
B) recession.
C) inflation.
D) expansion.

7. Controlling interest rates is an example of:
A) fiscal policy.
B) tax policy.
C) monetary policy.
D) exchange rate policy.

8. The alternation between recessions and expansions is known asthe:
A) unemployment rate.
B) long-run economic growth.
C) business cycle.
D) macroeconomy.

9. A recession in America is typically associated with:
A) a falling unemployment rate.
B) a decrease in the number of people living in poverty.
C) a decrease in the percentage of Americans with healthinsurance.
D) an increase in corporate profits.

10. The purpose of macroeconomic policy is to:
A) bring unemployment closer to the natural rate.
B) reduce the severity of recessions.
C) rein in excessively strong expansions.
D) bring unemployment closer to the natural rate and to reduce theseverity of recessions.

11. The trade balance is the difference between the value ofthe:
A) trade deficit and the budget deficit.
B) goods and services that one country sells to other countries andthe value of the goods and services it buys in return.
C) exchange rates of two countries that are engaged ininternational trade.
D) national debt and the foreign debt.

12. Increasing the total amount of available productive resourcesis the focus of __________.
A) macroeconomics
B) fiscal policy
C) monetary policy
D) microeconomics

13. The point on a business cycle when real GDP stops rising andbegins falling is a(n):
A) peak.
B) trough.
C) expansion.
D) recession.

14. During a recession, one will often observe:
A) aggregate output rising.
B) unemployment rates will be increasing while aggregate output isfalling.
C) employment rates will be rising.
D) zero unemployment rates.

15. Monetary policy involves:
A) changes in government spending.
B) changes in government tax receipts.
C) changes in the quantity of money.
D) changes in tax rates.

16. The trough of the business cycle:
A) comes right after the expansion phase.
B) comes before the recession phase.
C) is a temporary maximum level of real GDP.
D) is a temporary minimum level of real GDP.

17. Which one of the following statements about the U.S. economy isnot accurate?
A) Since the Second World War, aggregate output grew at a ratelower than the average annual growth rate of population.
B) Since the Second World War, aggregate output grew at a ratehigher than the average annual growth rate of population.
C) Since the Second World War, macroeconomic policy has helped makethe economy more stable.
D) Long-run growth per capita is the key to higher wages and arising standard of living.

18. An economic recovery is all of the following except:
A) economic growth of a sustained nature.
B) a short-run increase in aggregate production in aneconomy.
C) a time of increasing employment.
D) the end of the business cycle.

19. Which of the following would NOT be classified as amacroeconomic question?
A) How many people are employed in the economy as a whole?
B) What determines the overall level of prices in the economy as awhole?
C) What determines the overall trade in goods, services, andfinancial assets between the United States and the rest of theworld?
D) What determines the cost to a university or college of offeringa new course?

20. Which of the following statements regarding price level orinflation is correct?
A) Supply and demand can not explain why a particular good orservice becomes more expensive relative to other goods andservices.
B) Inflation affects only the more advanced countries whereas lessadvanced countries face deflation.
C) Prices of most goods and services remained stable during thegreat depression.
D) In general, when the economy is in recession and jobs are hardto find, inflation tends to fall.

21. If wages grew at a 5% rate last year and average prices grew ata 3% rate, then the average worker is:
A) better off.
B) worse off.
C) no better or worse off.
D) unaffected.

22. In an open economy:
A) the exchange rate is determined by the government.
B) specialization in activities with a comparative advantage is notpossible.
C) trade is only beneficial to the relatively larger economy.
D) there is trade in goods, services, or assets with othercountries.

23. Changes in government spending and taxes in an effort to changeoverall spending in an economy is:
A) fiscal policy.
B) monetary policy.
C) investment.
D) the stock market.

24. If an economy is open, this means that:
A) anyone can immigrate to the country.
B) trading with other countries makes up a portion of itseconomy.
C) it does not trade with other countries.
D) it will experience a drop in its real GDP.

25. Inflation is a situation where:
A) the average price level falls.
B) the average price level increases.
C) the average price level becomes negative.
D) the real price level falls.

26. The topics studied in macroeconomics include:
A) the price of a motorcycle.
B) the wages of engineers.
C) the average price level in the economy.
D) how much ice cream consumers buy.

27. A period of rising real GDP is a(n):
A) peak.
B) trough.
C) expansion.
D) recession.

28. The modern tools of macroeconomic policy are:
A) tax policy and antitrust policy.
B) fiscal policy and monetary policy.
C) monetary policy and exchange rate policy.
D) capital policy and labor policy.

29. A ârubber neckingâ traffic jam is an example of:
A) microeconomics in action.
B) individual behavior that has a large aggregate impact.
C) the paradox of thrift.
D) an outcome smaller than the sum of its parts.

30. The most painful consequence of a recession is:
A) rising unemployment.
B) increasing inflation.
C) increasing aggregate output.
D) higher interest rates.

31. Per capita economic growth is:
A) economic growth per unit of capital.
B) economic growth per person.
C) economic expansion over the business cycle.
D) sustained increase in aggregate output.

32. Keynesian economics stressed:
A) total spending.
B) the self-regulating power of free markets.
C) the long run.
D) that the Depression should run its course to bring down the highcost of living.

33. When an economy's overall production grows faster than itspopulation, this is referred to as:
A) long-run growth per capita.
B) an increase in nominal GDP.
C) deflation.
D) the paradox of thrift.

34. Fiscal policy attempts to affect the overall level of spendingin the economy through:
A) changes in the inflation rate.
B) changes in the quantity of money or the interest rate.
C) changes in tax policy or government spending.
D) discretionary regulation of profits and wages.

35. With regard to the aggregate price level, economists generallybelieve:
A) price stability is a desirable goal.
B) inflation is worse than deflation.
C) deflation is worse than inflation.
D) inflation actually benefits most retired people.

36. Recessions are periods when:
A) output rises.
B) the aggregate price level rises.
C) the unemployment rate is falling.
D) output and employment are falling.

37. Monetary policy attempts to affect the overall level ofspending in the economy by changes in:
A) taxes.
B) taxes and spending.
C) taxes and interest rates.
D) interest rates and the quantity of money.

38. The basic difference between an economic recession and economicdepression is that:
A) the latter is a shorter economic downturn than the former.
B) during recessions output falls faster than duringdepressions.
C) during depressions employment falls faster than duringrecessions.
D) the former is a longer economic downturn than the latter.

39. The central mission of modern macroeconomics is to prevent_____ from happening again.
A) recessions
B) inflation
C) deflation
D) anything like the Great Depression

40. Fiscal policy refers to:
A) the control of interest rates.
B) the control of government spending and taxations.
C) the control of the quantity of money.
D) the control of interest rates and of government spending.

byzantiumant655

1. The primary tool used by supply-side economists to eliminate macroeconomic problems is

A. the discount rate.

B. corporate tax rates.

C. government spending.

D. open market operations.

E. the reserve requirement.

2. When the Federal Reserve System buys government securities on the open market,

A. the money supply will decrease.

B. excess reserves at commercial banks will decrease.

C. excess reserves at commercial banks will increase.

D. interest rates will increase

3. One of the advantages of automatic stabilizers over discretionary fiscal policy is that automatic stabilizers

A. has a greater multiplier effect than discretionary policy.

B. is not subject to the time lag problems of discretionary policy.

C. does not produce a deficit during recessions as a discretionary policy does.

D. makes the actual budget a better reflection of the condition of the economy than the full-employment budget.

4. "I have promised to do everything in my power to reduce the federal deficit. That means reducing federal expenditures and, if necessary, increasing taxes. Under present conditions of full employment and steady prices, we can afford to bear the burden of this debt (i.e., pay off the debt) now instead of passing it on to our children and grandchildren."

If the policies of the Senator quoted above were adopted, what effects would be expected while these policies were being implemented?

A. higher inflation

B. increases imports

C. higher rates of economic growth

D. increased unemployment and idle capacity

5. An inflationary gap can be reduced or completely closed by

A. decreasing taxes while leaving government spending on goods and services unchanged.

B. decreasing government spending on goods and services while leaving taxes unchanged.

C. increasing government spending on goods and services while leaving taxes unchanged.

D. increasing both government spending on goods and services and taxes by the same amount.

6. Compared to fiscal policy, an advantage of monetary policy is its

A. greater flexibility.

B. highly selective impact on segments of the economy.

C. ability to eliminate cost-push inflation.

D. need for approval by Congress.

E. need for approval by the President.

7. An increase in government spending on goods and services which causes a budget deficit to exist

A. is always inflationary.

B. is more inflationary than equal increases in private spending.

C. is usually not inflationary when the economy is operating at its full-employment level of output.

D. will not necessarily cause serious inflation as long as there are unemployed resources in the economy.

8. Some analysts believe the tax cuts enacted during the President H.W. Bush administration represented a supply-side economic policy rather than a Keynesian fiscal policy because

A. the tax cuts were accompanied by decreases in interest rates.

B. the tax cuts were accompanied by increases in government spending.

C. the tax cuts were primarily aimed at upper-income groups and businesses.

D. the tax cuts were primarily aimed at middle income and lower-income groups.

9. When the federal government is stabilizing the economy by increasing taxes, monetary authorities should

A. take actions to decrease interest rates.

B. increase the supply of money.

C. buy government securities in the open market.

D. follow an expansionary money policy.

E. follow a contractionary money policy.

10. Suppose a commercial bank has demand deposits (checking accounts) of $400,000, actual reserves of $170,000, and a reserve requirement of 20%. This single commercial bank can lend a maximum of ______ and the banking system can increase loans by a maximum of ______

A. $90,000 and $450,000.
B. $90,000 and $360,000.
C. $90,000 and $170,000.
D. $170,000 and $450,000.

E. both can lend an unlimited amount.

11. Which of the following would most likely result if the federal government increased its spending without changing tax revenues during a period of full employment?

A. inflation

B. a recession

C. lower interest rates

D. a larger net exports deficit

12. Fiscal policy that emphasizes cutting taxes as a means of improving incentives to work, and invest would be characterized in aggregate demand - aggregate supply framework primarily a shift

A. left in the aggregate demand curve.

B. left in the aggregate supply curve.

C. right in the aggregate supply curve.

D. no shift in either the aggregate demand curve or the aggregate supply curve.

13. Which of the following will result in the greatest increase in aggregate expenditures/demand?

A. A $100 decrease in personal income taxes

B. A $100 increase in personal income taxes

C. A $100 increase in government expenditures

D. A $100 increase in government expenditures which is accompanied by a $100 increase in personal income taxes

E. Both A and C will have the same effect on aggregate expenditures

14. You are given the following information about aggregate demand for an economy: (1)consumption = $600 billion; (2) investment = $50 billion; (3) government purchases = $100 billion; and (4) net export = $20 billion. If the full-employment level of GDP for this economy is $720 billion, then what combination of actions would be most consistent to achieve full employment and stable prices?

A. an increase in government spending and taxes

B. decrease government spending and taxes

C. decrease government spending and increase taxes

D. increase government spending and decrease taxes

15. Advocates of fiscal policy agree that discretionary fiscal policy will stabilize the business cycle most when the federal government

A. continuously incurs budget deficits.

B. continuously runs budget surpluses.

C. balances its budget every year.

D. incurs budget deficits during recessions and budget surpluses during demand-pull inflations.

E. incurs budget surpluses during recessions and budget deficits during demand-pull inflations.

16. Discretionary fiscal policy that increases the government budget deficit has the same effect on equilibrium as

A. an increase in personal saving.

B. an increase in business investment.

C. a decrease in government spending.

D. a decrease in personal consumption expenditures

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ECON 1100 Chapter 20: Chapter 20 Review notes

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