Questions and Answers
Say's law is a dictum of economist J.B. Say that ___ creates its own ____
supply, demand
What is it called when reacting to changes in money prices rather than relative prices?
money illusion
If a worker whose wages double when the price level also doubles thinks they are better off, what are they suffering from?
money illusion
What is the term for the horizontal portion of the aggregate supply curve in the Keynesian framework?
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What causes the aggregate demand curve to shift inward or downward?
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What causes the aggregate supply curve to shift inward or downward?
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What exists whenever equilibrium real GDP per year is less than full-employment real GDP?
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What is it called when equilibrium real GDP per year is greater than full-employment real GDP?
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If equilibrium real GDP per year is GREATER THAN full-employment real GDP, there is a/an ____ gap.
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If equilibrium real GDP per year is LESS THAN full-employment real GDP, there is a/an ___ gap.
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The inflationary gap is also known as a(n) ___ gap.
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What type of inflation is caused by increases in aggregate demand not matched by increases in aggregate supply?
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What type of inflation is caused by decreases in short-run aggregate supply?
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If AD increases without matching increases in AS, there's ____ inflation.
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If short-run aggregate supply decreases, there's generally going to be ___ inflation.
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What are the five main assumptions of the classical model?
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Describe the shape of the long-run aggregate supply curve in the classical model.
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In the Classical Model, an increase in aggregate demand means the price level will ___.
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In the Classical Model, an increase in aggregate demand means the demand for labor will ___ which will cause wages to ___.
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In the Keynesian short-run aggregate supply curve, when aggregate demand falls while aggregate supply is stable, price level and real GDP will ___.
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In the Keynesian short-run aggregate supply curve, when aggregate demand increases while aggregate supply is stable, price level and real GDP will ___.
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An increase in demand in the Keynesian SRAS might cause a/an ___ gap.
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A decrease in demand in the Keynesian SRAS might cause a/an ___ gap.
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What are the three reasons why the Short-Run Aggregate Supply Curve is positively sloped?
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The ____ is vertical at full-employment real GDP, while the ____ slopes upward.
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The intersection of the LRAS curve with the aggregate demand curve determines ___.
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A RISE in the foreign exchange value of the dollar will cause the SRAS curve to shift ____ and the AD curve to shift ____.
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A DROP in the foreign exchange value of the dollar will cause the SRAS curve to shift ____ and the AD curve to shift ____.
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If AD shifts more than AS, equilibrium real GDP will ___.
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If AS shifts more than AD, equilibrium real GDP will ___.
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If product prices and wages and other input prices are 'sticky,' the short-run aggregate supply schedule can be ___.
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What happens to equilibrium real GDP below the level of full-employment real GDP in the short run due to an aggregate demand shock that shifts the curve leftward?
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What results from an aggregate demand shock that induces a rightward shift in the aggregate demand curve?
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Demand-pull inflation occurs when the aggregate demand curve shifts ___ along an upward-sloping short-run aggregate supply curve.
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Cost-push inflation occurs when the short-run aggregate supply curve shifts ____ along the aggregate demand curve.
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Study Notes
Say's Law and Money Illusion
- Say's Law asserts that "supply creates its own demand," meaning production generates the capacity and desire to purchase goods.
- Money illusion occurs when individuals react to nominal prices instead of relative prices, resulting in misperceptions about their economic well-being.
Aggregates and Economic Gaps
- The Keynesian short-run aggregate supply curve shows that excessive unemployment and unused capacity exist, represented by a horizontal portion.
- A recessionary gap arises when equilibrium real GDP is less than full-employment real GDP.
- An inflationary gap occurs when equilibrium real GDP exceeds full-employment real GDP, indicating overheating in the economy.
Inflation and Economic Fluctuations
- Demand-pull inflation is driven by rising aggregate demand without a corresponding increase in aggregate supply.
- Cost-push inflation results from a decrease in short-run aggregate supply, leading to higher prices despite stagnant or declining demand.
Classical Economic Model Assumptions
- Key assumptions of the classical model include: supply creating its own demand, pure competition, flexible wages and prices, self-interest motivation, and the inability to be deceived by money illusion.
- In this model, the long-run aggregate supply curve is vertical at full employment.
Responses in Aggregate Demand and Supply
- An increase in aggregate demand results in a rise in the price level, demand for labor, and subsequently wages within the classical framework.
- In the Keynesian perspective, a rise in aggregate demand while supply is stable leads to an increase in both price levels and real GDP.
Aggregate Supply Curve Characteristics
- The short-run aggregate supply curve has a positive slope for several reasons: flexibility in work hours, the ability to intensively use existing capital, and rising profits when prices increase without accompanying wage rises.
- The long-run aggregate supply curve remains vertical, denoting full-employment real GDP, while the short-run supply curve slopes upward, reflecting varying production levels in response to changes.
Shifts in Supply and Demand
- A rise in the dollar's foreign exchange value shifts the short-run aggregate supply curve right and the aggregate demand curve left.
- A drop in value results in the opposite effect: the short-run aggregate supply curve shifts left and the aggregate demand curve shifts right.
- If aggregate demand shifts more than aggregate supply, equilibrium real GDP declines; conversely, if aggregate supply shifts more, real GDP rises.
Short-Run Market Behavior
- Price and wage stickiness can make the short-run aggregate supply curve horizontal over certain ranges, allowing for significant changes in output in response to demand variations.
- Aggregate demand shocks that shift the demand curve leftward can create recessionary gaps, while rightward shifts can cause inflationary gaps, indicating pressure on prices and output in the economy.
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