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Macroeconomics CH. 33

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Macroeconomics CH. 33 ECN-120

bauer47 Notetaker

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These notes cover chapter 33 of Macroeconomics.
Principles of Macroeconomics
Joshua M. Phillips
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This 6 page Bundle was uploaded by bauer47 Notetaker on Thursday March 10, 2016. The Bundle belongs to ECN-120 at Iowa Central Community College taught by Joshua M. Phillips in Fall 2015. Since its upload, it has received 29 views. For similar materials see Principles of Macroeconomics in Economcs at Iowa Central Community College.


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Date Created: 03/10/16
Chapter 33- Aggregate Demand and Aggregate Supply 1) Introduction a. Over the long run, real GDP grows about 3% per year on average b. In the short run, GDP fluctuates around its trend i. Recessions: periods of falling real incomes and rising unemployment ii. Depressions: severe recessions (very rare) c. Short run economics fluctuations are often called business cycles d. Explaining these fluctuations is difficult, and the theory of economic fluctuations is controversial e. Most economists use the model of aggregate demand and aggregate supply to study fluctuations f. This model differs from the classical economic theories economists use to explain the long run 2) Classical economics- a recap a. The previous chapters are based on the ideas of classical economics, especially: i. The classical dichotomy: the separation of variables into two groups 1. Real- quantities, relative prices 2. Nominal- measured in terms of money ii. The neutrality of money: changes in the money supply affect nominal but not real variables b. Most economists believe classical theory describes the world in the long run, but not the short run c. i. The AD curve shows: the quantity of all G&S demanded in the economy at any given price level 1. Y = C + I + G + NX a. Assume G is fixed by gov’t policy b. To understand slope of AD: must determine how a change in P affects C, I, and NX c. Why is AD downward sloping? i. The Wealth Effect (p and c) 1. Suppose P rises a. The dollars people hold buy fewer G&S so real wealth is lower b. People feel poorer c. Result: C falls 2. Increase in P = Decrease in C ii. The Interest-Rate Effect (p and i) 1. Suppose P rises a. Buying G&S requires more dollars b. To get theses dollars, people sell bonds or other assets c. This drives up interest rates d. Result: I falls i. ( I depends negatively on interest rates ) 2. Increase in P = Increase in r = Decrease in I iii. The Exchange-Rate Effect (p and nx) 1. Suppose P rises a. US interest rates rise (IR effect) b. Foreign investors desire more US bonds c. Higher demand for $ in foreign exchange market d. US exchange rate appreciates e. Result: NX falls 2. Increase in P = increases the value of the dollar = Decrease in NX 2. Why the AD curve might shift a. Any event that changes C, I, G, or NX- except a change in P- will shift the AD curve b. Changes in C i. Stock market boom or crash ii. Preferences, re: consumption/ saving tradeoff iii. Tax hikes/cuts c. Changes in I i. Firms buy new computers, equipment, factories ii. Expectations, optimism/pessimism iii. Interest rates, monetary policy d. Changes in G i. Federal spending ii. State and local spending e. Changes in NX i. Booms/recessions in countries that buy our exports ii. Appreciation/depreciation resulting from international speculation in foreign exchange market f. Two big AD shifts i. The Great Depression (shift to the left) ii. The World War II Boom (shift to the right) ii. AS Curve shows total quantity of g&s firms produce and sell at any given price level 1. Upward-sloping is short run a. Over the period of 1-2 years, an increase in P causes an increase in the quantity of G&S supplied i. Why it matters: 1. If AS is vertical, fluctuations in AD do not cause fluctuations in output or employment 2. If AS slopes up, then shifts in AD do affect the output and employment ii. 3 Theories: 1. The Sticky-Wage Theory a. Imperfection: nominal wages are sticky in the short run, they adjust sluggishly i. Due to labor contracts and social norms ii. Firms and workers set the nominal wage in advance based on Pe, the price level they expect to prevail b. If P > Pe, revenue is higher but labor cost is not, production is more profitable so firms increase output and employment c. Higher P causes higher Y so the SRAS slopes upward 2. The Sticky-Price Theory a. Imperfection: many prices are sticky in the short run i. Due to menu costs, the costs of adjusting prices ii. Ex: cost of printing new menus, the time required to change price tags b. Firms set sticky prices in advance based on Pe c. Suppose the Fed increases the money supply unexpectedly, in the long run P will rise d. In the short run, firms without menu costs can raise their prices immediately e. Firms with menu costs wait to raise prices, meanwhile their prices are relatively low 3. The Misperceptions Theory a. Imperfection: firms may confuse changes in P with changes in the relative price of the products they sell b. If P rises above Pe, a firm sees its price rise before realizing all prices are rising 4. What they have in common a. All 3 theories, Y deviates from Yn when P deviates from Pe i. Y = Yn + a(P – Pe) ii. Y= output iii. Yn= natural rate of output LR iv. a>0, measures how much Y responds to unexpected changes in P v. P= actual price level vi. Pe= expected price level b. Why the SRAS curve might shift i. Everything that shifts LRAS shifts SRAS too ii. Pe shifts SRAS 1. If Pe rises, workers and firms set higher wages 2. At each P, production is less profitable, Y falls, SRAS shifts left c. The long-run equilibrium i. Pe = P ii. Y = Yn iii. Unemployment is at its natural rate 2. Vertical in long run a. Long-Run AS Curve: natural rate of output i. Amount of output the economy produces when unemployment is at its natural rate ii. Why its vertical 1. Yn determined by the economy’s stocks of labor, capital, and natural resources, and on the level of technology 2. An increase in P does not affect any of these so it does not affect Yn iii. Why it might shift 1. Any event that changes any of the determinants of Yn will shift LRAS 2. Ex: immigration increases L, causing Yn to rise 3. Changes in L or natural rate of unemployment a. Immigration b. Baby-boomers retire c. Gov’t policies reduce natural u-rate 4. Changes in K or H a. Investment in factories, equipment b. More people get college degrees c. Factories destroyed by a hurricane b. Over the long-run, technology progress shifts LRAS to the right i. Growth in the money supply shifts AD to the right ii. Result: ongoing inflation and growth in output iii. Economic Fluctuations 1. Caused by events that shift the AD and/or AS curves 2. Four steps to analyzing economic fluctuations a. Determine whether the event shifts AD or AS b. Determine whether curve shifts left or right c. Use AD-AS diagram to see how the shift changes Y and P in the short run d. Use AD-AS diagram to see how economy moves from new SR eq’m to new LR eq’m e. A-C need to know for test


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