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Macroeconomics: Aggregate Demand and Aggregate Supply

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  • What are the four components of real GDP?

    Consumption (C), Investment (I), Government purchases (G), and Net exports (NX).

  • What does the aggregate demand (AD) curve represent?

    The relationship between the price level and the quantity of real GDP demanded by households, firms, and government.

  • Why does the aggregate demand curve slope downward?

    Due to the wealth effect, interest-rate effect, and international-trade effect, where higher price levels reduce consumption, investment, and net exports.

  • What is the wealth effect in aggregate demand?

    As the price level rises, the real value of household wealth declines, leading to lower consumption.

  • How does the interest-rate effect influence aggregate demand?

    Higher price levels increase money demand, raising interest rates and discouraging investment spending.

  • What is the international-trade effect on aggregate demand?

    Higher domestic price levels make exports more expensive and imports cheaper, reducing net exports.

  • What causes a movement along the aggregate demand curve?

    A change in the price level holding other factors constant.

  • What causes a shift of the aggregate demand curve?

    A change in any component of real GDP other than the price level, such as government purchases or consumer expectations.

  • Name three variables that shift the aggregate demand curve.

    Interest rates, government purchases, and households' expectations of future income.

  • How do higher interest rates affect aggregate demand?

    They raise borrowing costs, reducing consumption and investment, shifting AD left.

  • What is the difference between short-run aggregate supply (SRAS) and long-run aggregate supply (LRAS)?

    SRAS is upward sloping due to sticky wages/prices; LRAS is vertical, reflecting potential GDP independent of price level.

  • Why is the SRAS curve upward sloping?

    Because wages and prices are sticky due to contracts, slow adjustments, and menu costs, causing output to increase with price level.

  • What factors cause the SRAS curve to shift?

    Changes in labor force, capital stock, productivity, expected future price level, and supply shocks like natural disasters.

  • What happens to SRAS if workers expect higher future prices?

    SRAS shifts left as wages and prices rise in anticipation of higher costs.

  • What is a supply shock in macroeconomics?

    An unexpected event that shifts the SRAS curve, such as a sudden increase in oil prices or a pandemic.

  • What defines long-run macroeconomic equilibrium?

    When AD and SRAS intersect at the LRAS level, meaning GDP is at full employment and price expectations are met.

  • How does a decrease in aggregate demand affect the economy in the short run?

    It causes a recession with lower output and employment as equilibrium moves left along SRAS.

  • How does the economy return to long-run equilibrium after a demand shock?

    Wages and prices adjust, shifting SRAS to restore equilibrium at potential GDP but with a different price level.

  • What is stagflation and what causes it?

    A combination of inflation and recession caused by a negative supply shock shifting SRAS left.

  • How did the Covid-19 pandemic affect aggregate demand and supply?

    Both AD and SRAS shifted left due to reduced consumption, investment, and supply disruptions, lowering GDP.

  • What is the dynamic aggregate demand and aggregate supply model?

    A model incorporating continual growth in real GDP and shifts in AD, SRAS, and LRAS over time.

  • What causes inflation in the dynamic AD-AS model?

    When aggregate demand grows faster than aggregate supply, pushing prices up over time.

  • What are the main causes of the 2007–2009 recession?

    The end of the housing bubble, the financial crisis, and a rapid increase in oil prices (supply shock).

  • What is the Keynesian view on wage and price stickiness?

    Wages and prices are sticky, causing short-run fluctuations in output and employment.

  • What does the Monetarist model emphasize?

    Fluctuations in real output are mainly caused by changes in the money supply; advocates steady monetary growth.

  • What is the New Classical model's key assumption?

    Workers and firms have rational expectations and adjust quickly, minimizing output fluctuations.

  • What does the Real Business Cycle model focus on?

    Real productivity shocks as the main cause of business cycles, with aggregate supply vertical even in the short run.

  • What is the Austrian theory of the business cycle?

    Central bank-induced low interest rates cause overinvestment, leading to cycles of boom and bust.