Aggregate Supply, Demand, and Economic Growth Factors
Aggregate Supply and Demand Dynamics
Short-Run and Long-Run Aggregate Supply
Determinants of Short-Run Aggregate Supply (SRAS)
What are the determinants of short-run aggregate supply? Changes in input prices, taxes, and business and inflationary expectations.
Determinant of Aggregate Supply (AS)
What is a key determinant of aggregate supply? Productivity.
SRAS Curve Slope
The short-run aggregate supply curve slopes upward because profits increase at high price levels and because many input prices are slow to change in the short run.
Long-Run Aggregate Supply (LRAS)
The long-run aggregate supply curve is vertical because the economy will gravitate to the position of full employment when all variables are flexible.
Shifts in SRAS
Which of these will shift the short-run aggregate supply curve to the right? An increase in immigration from other countries.
Which of these will shift the short-run aggregate supply curve to the left? An increase in the minimum wage.
If oil prices decline, the short-run aggregate supply curve shifts right and output supplied will increase.
What happens if business expectations improve? Aggregate supply shifts to the right.
Aggregate supply increases when there is a decrease in firms’ market power.
Which of these will shift the aggregate supply curve to the right? An increase in the investment of human capital.
Aggregate Demand (AD) and Policy Effects
Events Causing AD Increase (Shift Right)
Which event causes an increase in aggregate demand? Falling interest rates.
Decreased interest rates will shift the aggregate demand curve to the right and increase output demanded.
Which event will shift the aggregate demand curve to the right? A new government program implemented to eliminate poverty (due to increased consumer spending, investment spending, government spending, or net exports).
Events Causing AD Decrease (Shift Left)
Which event causes a decrease in aggregate demand? Increases in taxes.
Which factor will cause the aggregate demand curve to shift to the left? An appreciation of the dollar.
Econia’s currency appreciates. This will cause aggregate demand to fall.
Increased taxes will shift the aggregate demand curve to the left and decrease output demanded.
Impact of Shifts on Price and Employment
What would cause inflation and employment to increase? A rightward shift of the aggregate demand curve.
What would cause the price level to rise and employment to increase? A shift to the right of the aggregate demand curve.
What would cause the price level to rise and employment to decrease? A shift to the right of the short-run aggregate supply curve.
Movement Along the AD Curve
Which of these would cause a movement along a country’s aggregate demand curve, but not a shift in its aggregate demand curve? An increase in a country’s CPI, meaning that household income does not buy as much.
International Trade Effects
If the British pound sterling appreciates against the US dollar, England buys more US goods, causing the US aggregate demand curve to shift to the right.
If a country’s currency appreciates, what impact will it have on aggregate supply? Short-run aggregate supply will rise due to lower prices on imported inputs.
Macroeconomic Equilibrium and Policy Outcomes
Short-Run vs. Long-Run Outcomes
Suppose the economy is at full employment, and energy prices spike. In the short run, output will decrease; in the long run, output will remain unchanged.
Suppose the economy is at full employment, and consumers spend more than usual. In the short run, prices will increase; in the long run, prices will increase.
Suppose the economy is at full employment, and consumers spend more than usual. In the short run, output will increase; in the long run, output will remain unchanged.
Suppose the economy is at full employment and a booming stock market encourages consumption spending to rise dramatically. What would be the MOST likely long-run impact? Real GDP first rises and then falls back to long-run equilibrium.
Inflation and Unemployment
In the long run, attempts to expand beyond an economy’s natural rate of unemployment tend to result in increased inflation.
A solution to the simultaneous emergence of deflation and unemployment is to use policies that shift the aggregate demand curve to the right.
Fiscal Policy and Full Employment
Which statement(s) about fiscal policy and aggregate demand is/are correct? An increase in government spending would increase aggregate demand.
If the economy is at full employment, increases in government spending are primarily absorbed by price increases.
Suppose the government increases aggregate demand to a level that increases GDP above its long-run equilibrium level. What sequence of events would follow? Prices rise; GDP increases; workers demand higher wages; short-run aggregate supply shifts to the left; GDP drops.
Firm Behavior and Expectations
Suppose last year a firm expected inflation this year to be 10%, and based on this expectation, it signed a contract with its workers agreeing to pay them $20 an hour. Yet the actual inflation turns out to be only 3%. The firm overestimated inflation! As a result of this misestimation during the year the contract is in place (this year), the firm will increase the quantity of output supplied.
In the short run, a decrease in market power (or monopolization) will decrease the price level.
Economic Growth and Productivity
GDP Growth Rate
Which country will double its real GDP per capita most quickly? The country with the highest growth rate.
Standard of Living
If a country’s population increases at a higher rate than the growth rate of its real GDP, the standard of living in the country has decreased.
Sources of Growth
Improvements in technology explain most of the economic growth in recent decades.
Increases in technology often lead to economic growth.
An increase in physical capital per worker will lead to more output per worker.
On-the-job training can lead to an increase in the quality of the labor force.
Productivity Factors
Which of these is NOT a source of productivity growth? A decrease in the capital-to-labor ratio.
The capital-to-labor ratio is high in rich countries.
Given the form of a typical production function, which of these would have the greatest impact on the output of a country? A (Total Factor Productivity) increases by 50%.
Short-Run Growth Example
Which of these would be an example of a situation associated with short-run economic growth? A country reports that employment rises by 200,000 workers, reducing the unemployment rate.
GDP, Investment, and Measurement
Investment Definition
Investment in structures, equipment, software, and net inventory is known as gross private domestic investment.
Which of these is included in gross private domestic investment? An increase in business inventories.
GDP Calculation
Everything else the same, if investment expenditures rise by $300 billion and imports increase by $300 billion, then GDP has no change.
Company DEF produces gizmos. One particular batch cost $50,000 to produce. Because market conditions were bad at the time of sale, they were sold at a loss for $40,000. The value of the gizmos included in the GDP is $40,000 (the final sale price).
Price Level Impact
A falling price level will not impact real GDP (in the long run).
A falling price level, or deflation, will decrease nominal GDP.
Opportunity Cost and Marginal Analysis
Opportunity Cost Principle
Opportunity costs exist because using resources for one activity means that their use elsewhere must be given up.
Calculating Opportunity Cost
You are deciding whether to stay home to do your laundry rather than work at your job and make $60. If you are willing to pay $80 to have someone else do your laundry, what would be the opportunity cost of a third option: going out drinking with your friends? $80.
John chose to buy a pizza. If he had not bought the pizza, he would have bought either a hot dog or a hamburger. John’s opportunity cost of buying the pizza is whichever alternative, the hot dog or the hamburger, has the next highest value to John.
Marginal Decisions
A person will decide to take the day off work if the marginal cost is less than the marginal benefit.
Suppose that a store sells candy bars for $0.89 for one and $1.50 for two. The marginal cost of the second candy bar is $0.61 (because it is $1.50 – $0.89).
Economic Decision Making
You can buy an electronic game for $25 at the Campus Store or for $15 at a nearby shopping mall. You can buy a computer for $1000 at the Campus Store or for $990 at the nearby mall. Should your “where to buy” decision be the same or different in the two cases? Different, because the computer is a higher surplus item.
An airline finds that its morning flights are half-empty, but the mid-afternoon flights are full. Which would be the MOST plausible statement for an economist to make? Cut the prices of early morning flights and raise the prices of afternoon flights.