Aggregate Demand (AD)

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Questions and Answers

How does the international effect contribute to the downward slope of the aggregate demand curve?

When domestic prices drop, other countries want to import more goods, increasing exports and aggregate demand.

Explain how changes in expectations can shift the aggregate demand (AD) curve and provide a specific example.

Changes in expectations about future economic conditions can influence current spending and investment decisions. For example, if consumers expect a recession, they may reduce spending, shifting the AD curve to the left.

What are the primary determinants of shifts in the long-run aggregate supply (LRAS) curve, and why are these factors considered long-run?

Shifts in the LRAS curve are primarily determined by changes in capital, technology, entrepreneurship, or resources. These factors are considered long-run because they typically involve fundamental changes to the economy's productive capacity, which take time to develop.

Contrast the classical and Keynesian perspectives on how an economy self-corrects from a recessionary gap.

Classical economists believe that wages and prices will adjust downward, restoring full employment. Keynesians advocate for government intervention through fiscal policies to stimulate demand and close the gap. Signup and view all the answers

How does Say's Law relate to the classical economic perspective, and what implications does it have for government intervention in the economy?

Say's Law posits that "supply creates its own demand," implying that production is sufficient to drive demand. This reduces the need for government intervention, as the market is believed to self-correct. Signup and view all the answers

Describe the policies that classical economists advocate to promote economic growth, and explain why they emphasize these particular factors.

Classical economists emphasize policies encouraging saving and investment, formalizing property rights, reducing corruption, providing education, and encouraging technological innovation. These factors drive capital accumulation and productivity, fostering economic growth. Signup and view all the answers

Distinguish between demand-pull and cost-push inflation, and explain how each type of inflation might be addressed with different economic policies.

Demand-pull inflation arises from excessive demand, often addressed by contractionary monetary or fiscal policies. Cost-push inflation stems from rising production costs and may require supply-side interventions or policies to manage inflationary expectations. Signup and view all the answers

Explain the concept of 'functional finance' and how it differs from 'sound finance' in the context of government budgeting.

Functional finance prioritizes government spending and taxing decisions based on their effect on the economy, possibly leading to deficits. Sound finance advocates for a balanced budget, with government spending equal to or less than tax revenues. Signup and view all the answers

What are the potential drawbacks of using expansionary fiscal policy to address a recessionary gap, particularly in terms of its impact on trade balance?

Expansionary fiscal policy can lead to increased imports through increased income, which may negatively affect the trade balance by increasing the trade deficit. Signup and view all the answers

Describe the crowding out effect and explain how government borrowing to finance a deficit can lead to a reduction in private investment.

Crowding out occurs as government borrowing increases interest rates, making it more expensive for private businesses to borrow and invest, leading to a decrease in private investment. Signup and view all the answers

How do automatic stabilizers function, and what are some examples of these mechanisms in a modern economy?

Automatic stabilizers counteract economic fluctuations without requiring explicit government action. Examples include welfare programs and income-based taxing. Signup and view all the answers

What are 'rainy-day funds' and how do they relate to the principle of sound finance at the state government level?

Rainy-day funds are state-established reserves built during surpluses. They exemplify sound finance by providing a buffer for economic downturns, adhering to the principle of balancing the budget over time. Signup and view all the answers

Explain the implications of the interest rate effect on aggregate demand when prices drop.

When prices drop, people feel wealthier and save more, increasing the supply of loanable funds. This lowers interest rates, stimulating investment and aggregate demand. Signup and view all the answers

What are the potential limitations of using fiscal policy to address economic problems, as highlighted by the concept of 'lags'?

Fiscal policy is subject to data, recognition, legislative, implementation, and effectiveness lags, which can delay and complicate its impact on the economy. Signup and view all the answers

How does the level of potential output (Yp) relate to the natural rate of unemployment, and what does it signify about the economy's efficiency?

Potential output (Yp) represents the level of production achievable when the economy is operating at full capacity with unemployment at its natural rate, indicating efficient resource utilization. Signup and view all the answers

Explain why expansionary fiscal policy might face limitations due to the proportion of the budget that is discretionary.

A small percentage of the budget is discretionary, limiting Congress's ability to quickly change taxes and spending in response to economic conditions, constraining the effectiveness of fiscal policy. Signup and view all the answers

What is the significance of the debt-to-GDP ratio, and how does it reflect a country's ability to manage its debt obligations?

The debt-to-GDP ratio indicates a country's capacity to repay its debts by comparing its total debt to its economic output, providing a measure of its financial health. Signup and view all the answers

Describe how the structure of who owns U.S. debt (e.g., domestic vs. foreign entities) can influence the nation's economic stability and policy decisions.

The structure of debt ownership (domestic vs. foreign) affects macroeconomic stability. High foreign ownership may increase vulnerability to external economic shocks and influence exchange rates and monetary policy. Signup and view all the answers

How does the classical critique of Keynesian economics view the role of government intervention in correcting economic downturns, particularly in relation to the economy's self-correcting mechanisms?

Classical economists criticize Keynesian intervention, believing the economy will self-correct to the potential output (Yp) without government interference, rendering fiscal policies unnecessary and potentially harmful. Signup and view all the answers

Explain how changes in input prices or production costs can cause shifts in the short-run aggregate supply (SAS) curve, and provide a real-world example.

Changes in input prices or production costs shift the SAS curve. For instance, an increase in oil prices raises production costs, shifting the SAS curve to the left. Signup and view all the answers

Flashcards

GDP Equation

Y = Consumption + Investment + Government Spending + (Exports - Imports). It represents the total demand in an economy.

What is Contractionary Policy?

Government spending decreases and taxes increase, leading to decreased consumption and aggregate demand.

What is Expansionary Policy?

Government spending increases and taxes decrease, leading to increased consumption and aggregate demand.

What is Disposable Income?

Income minus taxes; the amount of income households have available for consumption and saving after paying taxes.