Economics Chapter 32: Business Fluctuations

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Questions and Answers

What must a positive shock to spending increase in the short run?

Only the real growth rate

Only inflation

Inflation or the real growth rate (correct)

Neither inflation nor the growth rate

In the long run, an increase in spending will primarily affect which variable?

Interest rate

Inflation rate (correct)

Employment rate

Real growth rate

What phenomenon occurs when workers mistake a nominal wage increase for a real wage increase?

Menu costs

Price rigidity

Labor market inefficiency

Nominal wage confusion (correct)

What are menu costs?

Costs of changing prices Signup and view all the answers

Why might firms delay changing prices following a rise in demand?

Uncertainty about the permanence of market changes Signup and view all the answers

What eventually happens to inflation expectations after a positive demand shock?

They adjust Signup and view all the answers

What happens to the growth rate after the initial inflation increase from a positive demand shock?

It returns to the Solow rate Signup and view all the answers

What may cause workers to demand higher wages after inflation rises?

To keep pace with inflation Signup and view all the answers

What term describes the costs associated with changing the prices of goods and services?

Menu costs Signup and view all the answers

What happens to the inflation rate when aggregate demand falls due to a decrease in the money supply?

The inflation rate is reduced Signup and view all the answers

Which of the following is a consequence of a decrease in aggregate demand?

Induction of a recession Signup and view all the answers

What type of shocks increase aggregate demand?

Increased export growth Signup and view all the answers

Which of the following factors is associated with a negative shock to aggregate demand?

Reduced wealth Signup and view all the answers

Which component of spending is NOT mentioned as being stable over time?

Savings (S) Signup and view all the answers

What is especially sticky in the downward direction during a recession?

Prices and wages Signup and view all the answers

Which factor can lead to a faster growth rate of spending?

Increased wealth Signup and view all the answers

What is the effect of a slower growth in the money supply on aggregate demand (AD)?

It decreases AD. Signup and view all the answers

What initiated the Great Recession?

A run on shadow banks. Signup and view all the answers

Why did investors grow nervous about the shadow banking system during the Great Recession?

It was unclear which institutions were most exposed. Signup and view all the answers

What was a primary consequence of the decline in credit availability during the Great Recession?

Decrease in aggregate demand. Signup and view all the answers

What impact did the COVID-19 pandemic have on factory productivity?

It decreased productivity. Signup and view all the answers

How much did the unemployment rate rise during the COVID-19 pandemic?

From 3.5% to 15%. Signup and view all the answers

During the COVID-19 recession, which way did the LRAS curve shift?

Shifted to the left. Signup and view all the answers

Which factor contributed to a leftward shift in aggregate demand during the COVID-19 recession?

School shutdowns. Signup and view all the answers

What does the equation M + v equal in the context of the Aggregate Demand curve?

Inflation + Real growth Signup and view all the answers

If the growth rate of the money supply is 5%, velocity is constant at 0%, and real growth is also 0%, what is the inflation rate?

5% Signup and view all the answers

What happens to the Aggregate Demand curve when spending growth increases?

It shifts up and to the right. Signup and view all the answers

What does an AD curve with a slope of -1 indicate?

A 1% increase in real growth reduces inflation by 1%. Signup and view all the answers

Which of the following variables is NOT included in the equation M + v?

Real GDP growth Signup and view all the answers

When only the money supply grows at 5% with constant velocity and no additional goods, what can be inferred about prices?

Prices must increase. Signup and view all the answers

If the money growth is 5%, velocity is constant at 0%, and real growth is 3%, what is the inflation rate calculated?

2% Signup and view all the answers

What are the two outcomes of increased spending according to the Aggregate Demand curve?

Higher inflation or higher real growth Signup and view all the answers

What does the term 'business fluctuations' refer to?

Fluctuations in the growth rate of real GDP around its trend growth rate Signup and view all the answers

What typically happens during a recession?

There is a decline in real income and employment Signup and view all the answers

Which economic model helps understand the behavior of booms and recessions?

Aggregate demand and aggregate supply (AD–AS) model Signup and view all the answers

What does the aggregate demand curve illustrate?

Combinations of inflation and real growth consistent with a specified rate of spending growth Signup and view all the answers

What effect does higher business taxes have on the long-run aggregate supply curve?

It shifts the curve to the left. Signup and view all the answers

What is the average growth rate of real GDP in the U.S. over the past 60 years?

3.1% per quarter Signup and view all the answers

Which of the following is an example of a negative shock affecting LRAS?

Higher oil prices. Signup and view all the answers

What are 'shocks' in the context of the AD–AS model?

Unexpected economic disturbances that can affect growth rates Signup and view all the answers

Which of the following best characterizes a recession?

Decline in growth of real GDP and rising unemployment Signup and view all the answers

What happens to the long-run aggregate supply curve when there is a productivity boom?

It shifts to the right. Signup and view all the answers

How does a decrease in aggregate demand affect the short-run aggregate supply curve?

It decreases both inflation and growth rate. Signup and view all the answers

Which curve in the AD–AS model represents total production in an economy in the long run?

Long-run aggregate supply curve Signup and view all the answers

In the context of short-run aggregate supply, what is the relationship between inflation rate and growth during sticky prices?

There is a positive relationship. Signup and view all the answers

What is defined as an aggregate demand shock?

A rapid and unexpected shift in the AD curve. Signup and view all the answers

What effect does smooth production without disruption have on the long-run aggregate supply curve?

It shifts the curve to the right. Signup and view all the answers

Which of these is a characteristic of the short-run aggregate supply curve?

It shows a positive relationship between inflation and real growth. Signup and view all the answers

Study Notes

Chapter 32: Business Fluctuations: Aggregate Demand and Supply

Economic growth is not smooth. Real GDP in the US has averaged 3.1% per quarter over the past 60 years, but growth fluctuates from -5% to over 8%.
Recessions are periods of widespread decline in real income and employment, a significant concern for policymakers and the public.
Business fluctuations are changes in the growth rate of real GDP around its trend growth rate.
A recession is a significant and widespread decline in real income and employment.
The AD-AS model helps understand booms and recessions. This model uses the aggregate demand (AD) curve, long-run aggregate supply (LRAS) curve, and short-run aggregate supply (SRAS) curve.
The aggregate demand curve (AD) shows inflation and real growth combinations consistent with a specific spending growth rate.
The AD curve is derived using the quantity theory of money in dynamic form: M + v = p + Yr , where M = money supply growth rate, v = velocity, p = price growth (inflation), and Yr = real GDP growth rate.
Inflation and real growth that add up to a specific spending growth rate, like 5%, will fall on the same AD curve. A slope of -1 means a 1 percentage point increase in real growth reduces inflation by 1%.
Shifts in the AD curve are caused by changes in spending growth. Increased spending leads to a shift upward and to the right, whilst decreased spending causes a shift inward.
The long-run aggregate supply (LRAS) curve is a vertical line at the Solow growth rate, which is the economy's potential growth rate, determined by labor and capital stock increases and productivity improvements. The Solow growth rate is not influenced by the inflation rate.
Real shocks impacting productivity (e.g., wars, weather, new technologies), shift the LRAS curve. Positive shocks move it right; negative shocks, left.
Aggregate Demand (AD) shocks are shifts in the AD curve. Positive shocks raise both inflation and growth rate, but negative shocks lower both.
Short-run aggregate supply (SRAS) shows the positive relationship between the inflation rate and real growth during times where prices and wages are inflexible. In the short-run, AD increases (e.g. due to rise in spending), inflation and growth rate increase. Conversely, a decrease in AD decreases both inflation and growth.
Menu costs are costs firms experience when changing prices. Nominal wage confusion occurs when workers respond to nominal wages rather than real wages (wage corrected for inflation).

Introduction

Economic growth is not a smooth process
Real GDP has averaged 3.1% per quarter over the last 60 years.
Growth has fluctuated between -5% up to more than 8%
Recessions are specifically of concern due to typical unemployment increases during them

Definition

Business fluctuations are the changes in the growth rate of real GDP around its trend growth rate.
A recession is a widespread, significant decline in real income and employment.

Introduction (cont.)

The model of AD-AS will help understand booms and recessions.

Takeaway

The AD-AS model can analyze real GDP growth rate fluctuations.
Real shocks cause LRAS shifts, while AD shocks affect the AD curve.
Inflexible wages and prices cause an upward-sloping SRAS curve.
The Great Depression was marked by a series of unfortunate aggregate demand and real shocks.

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Description

Explore the dynamics of business fluctuations and their impact on economic growth in this quiz on Chapter 32. Understand the role of aggregate demand and supply (AD-AS model) in analyzing recessions and booms. Test your knowledge on GDP trends and the factors influencing real income and employment.