Economics Chapter 14: AD and AS Models

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Questions and Answers

What does the short-run equilibrium condition AD = SRAS imply about the economy?

The economy is producing above its potential GDP.

Planned expenditures are aligned with production plans. (correct)

There is a surplus of goods in the market.

Inflation rates are at their highest point.

What happens at the intersection of short-run aggregate supply and aggregate demand curves?

Inflation is expected to rise indefinitely.

Equilibrium price level is established. (correct)

A natural increase in output is guaranteed.

Market imbalance occurs.

If the economy is experiencing short-run equilibrium and there is a decrease in aggregate demand, what is the expected outcome?

Unemployment will significantly decrease.

Both production and prices will rise.

There will be no impact on production levels.

Firms will reduce production and prices. (correct)

What characterizes long-run equilibrium in the AD-AS model?

Actual output equals potential GDP, or natural rate of output. Signup and view all the answers

What does a price adjustment imply in the context of aggregate demand and short-run aggregate supply?

Market imbalances will lead to price changes. Signup and view all the answers

If the economy is initially at long-run equilibrium but then faces a negative macroeconomic shock, what outcome might occur?

The economy will shift to a new equilibrium below potential GDP. Signup and view all the answers

In the context of the AD-AS model, what is a key difference between short-run and long-run aggregate supply?

Long-run aggregate supply reflects potential output unaffected by demand fluctuations. Signup and view all the answers

What can be inferred from a sustained increase in the productive capacity of the economy by 1 - 2% per year?

There is an increase in potential GDP. Signup and view all the answers

What is the implication of firms cutting production in the short run?

Output levels are dropping below the equilibrium. Signup and view all the answers

What effect does a positive shock to Aggregate Demand (AD) typically have on the economy in the short run?

It results in an increase in overall spending. Signup and view all the answers

What is indicated by the vertical Long-run Aggregate Supply (LRAS) curve?

In the long run, output returns to its natural rate. Signup and view all the answers

Which scenario is an example of a negative shock to Aggregate Demand?

A pandemic that disrupts economic activity. Signup and view all the answers

Which result follows a contraction in Aggregate Demand in the short run?

Decreased price levels and entry into recession. Signup and view all the answers

What is a common economic effect of an overheating economy due to increased AD?

Upward pressure on wages and potential inflation. Signup and view all the answers

During a period of economic recession caused by a negative shock to AD, what happens to the equilibrium output?

It falls below the natural rate of output. Signup and view all the answers

What does a decrease in Aggregate Demand typically cause in terms of price levels?

A decrease in price levels as spending declines. Signup and view all the answers

What economic condition is often illustrated by the aggregate supply curve shifting to the left?

A decrease in SRAS due to rising production costs. Signup and view all the answers

What term is used to describe a period of contracting real GDP and rising unemployment?

Recession Signup and view all the answers

How is long-run real GDP primarily determined?

Levels of inputs and productivity Signup and view all the answers

Which of the following accurately describes the aggregate demand curve?

It represents the total amount spent on goods and services at various price levels. Signup and view all the answers

What significant economic event occurred that interrupted 15 years of consistent GDP growth in Canada?

The financial crisis of 2008 Signup and view all the answers

What is a depression considered in economic terms?

A severe recession Signup and view all the answers

Which of the following statements about unemployment during economic downturns is true?

Unemployment tends to rise significantly as real GDP decreases. Signup and view all the answers

What does the aggregate supply curve represent in relation to price levels?

The total quantity of goods produced at various price levels. Signup and view all the answers

What does the term 'economic shocks' refer to?

Unexpected events that significantly impact the economy Signup and view all the answers

What is the likely outcome if the aggregate demand decreases?

A decrease in the price level and potential recession Signup and view all the answers

In the short-run, what primarily influences fluctuations in equilibrium real GDP?

Shifts in aggregate demand and supply Signup and view all the answers

Study Notes

Chapter 14: Aggregate Demand and Aggregate Supply

This chapter examines the market for goods and services
Real GDP fluctuates, usually growing but often unevenly
Recessions occasionally occur
The AD-AS model is used to determine equilibrium real GDP and explain its fluctuations, mainly focusing on short-to-medium-term fluctuations
Real GDP has ups and downs, following a business cycle
The business cycle is not regular, unlike seasonal patterns
Canada experienced about 15 consecutive years of growth in real GDP before 2008
Growth resumed in 2009, but at a slower pace
The pandemic significantly impacted growth
A recession is characterized by contracting real GDP and rising unemployment
A depression is a severe recession

Economic Fluctuations

Economic fluctuations are irregular and unpredictable
Real GDP and investment spending are not consistently positive and have ups and downs
Unemployment rises significantly when real GDP falls, even slightly
Economic trends show strong positive correlation, even if the magnitude varies
Economic data from 1870-2017 illustrate irregular fluctuations in real GDP
Macroeconomic instability and unpredictability are crucial concepts to understand

Model of AD and AS

The model explains short-run fluctuations in equilibrium real GDP
Long-run real GDP is determined by input levels and productivity, discussed in previous chapters
The model focuses on short-run variations around the longer-term trend in real GDP

AD Curve

The AD curve illustrates the relationship between the overall price level and real GDP
The relationship has a negative slope
Three main reasons for the negative slope are the wealth effect, the real exchange rate effect, and the interest rate effect
Shifts in the AD curve are caused by factors other than price, impacting expenditure levels
Increases in expenditure (e.g., investment, net exports, government spending, consumption) cause the AD curve to shift to the right
Decreases in expenditure cause the AD curve to shift to the left

Aggregate Supply

Aggregate Supply (AS) has two components: short-run and long-run
The short-run AS curve slopes upward
The long-run AS curve is vertical
The long-run aggregate supply (LRAS) level is determined by factors influencing production potential (land, labor, capital, and technology) and is not affected by the price level

Shifts in AS Curve

Factors impacting productivity or costs, not the price level, shift the short-run aggregate supply (SRAS) curve
Increases in productivity or decreases in costs shift SRAS to the right
Decreases in productivity or increases in costs shift SRAS to the left
Any change in the price level moves along the AD or AS curve

Shifts in LRAS curve

Factors like technological advancements, production capacity, human capital, labor force, and natural resources impact the long-run aggregate supply (LRAS) curve
An increase in these factors shifts the LRAS curve to the right.
A decrease in these factors shifts the LRAS curve to the left.

Applications of AD-AS Model

The model helps analyze macroeconomic shocks, especially AD and AS shocks, which are shifts in the respective curves
Positive and negative shocks to AD or AS cause shifts, and the model predicts impacts on equilibrium output and price levels

Equilibrium Analysis

Equilibrium occurs when planned expenditure matches production plans, with the price level adjusting to ensure consistency, similar to the microeconomic supply and demand model.

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Description

This quiz covers Chapter 14 on Aggregate Demand and Aggregate Supply, focusing on the fluctuations of real GDP and the business cycle. It highlights key concepts including recessions, depressions, and the impact of economic events like the pandemic. Test your understanding of how these factors contribute to the equilibrium in the economy.