Chapter 28: Aggregate Demand and Aggregate Supply – page 1
Shocks to the System – In 2008, the chairman of the Federal Reserve was ____________________________.
Generally speaking, the Federal Reserve fights unemployment by
_______________________________________
and fights inflation by _____________________________________. It is less clear what to do when the
economy is experiencing _______________________ - both high inflation and high unemployment. This
situation occurred in the 1970’s and 2008 when recessions were driven by
________________________________________________.
Aggregate Demand – The Aggregate Demand (AD) curve displays the relationship between ______________
_______________________________________________. It is different from the demand curve developed
earlier in the class in that
_____________________________________________________________________________
The x-axis of the AD-AS model can be labeled either with _______ ______ or ________________
____________.
The AD curve is ________________ sloping, meaning that at higher prices a _______________ Q is
demanded.
Why is the AD Curve Downward Sloping? The formula for the Q of domestically produced final goods and
services demanded during a given period is ___ + ___ + ___ + ___ - ____. Of these, ____, ____, and X-Im
are levels set in the private sector that are adversely impacted by _____________ prices. These are the
categories we will focus on as we learn about the wealth effect and the interest-rate effect.
The Wealth Effect – When the aggregate price level (PL) rises, people can afford less stuff. Therefore, they are
________ wealthy. When the PL falls, people can afford more stuff. They are ___________ wealthy. This
change in consumption patterns brought on by a change in P is called the __________ ___________ (of a
change in PL).
The Interest Rate Effect – When there is a higher PL, people need more ________________. They must then
sell illiquid assets and convert them into liquid assets. Higher prices have effectively cut into people’s ability
to ______.
As savings decrease, the ______________ ________ rises. Higher interest rates decrease ___, as many
projects’ projected rate of _____________ move below the cost of borrowing. C is reduced through the
negative multiplier effect, and by the fact that more of people’s disposable income will now be used to pay
interest of money borrowed.
Make a note that higher interest rates also affect net exports. Foreigners would want our higher interest rates,
D for our currency would increase, our currency would appreciate, and our goods would be more expensive
abroad.
The AD Curve and the I-E Model – Describe how the I-E model is related to the AD curve. ____________
____________________________________________________________________________________________
Shifts of the Aggregate Demand Curve - Describe how each of the following can cause a shift in the AD curve.
Changes in expectations _______________________________________________________________________
Changes in wealth ____________________________________________________________________________
When does change in wealth cause a movement along the AD curve? ___________________ a shift?
___________
Size of existing physical capital __________________________________________________________________
Fiscal Policy - ________________________________________________________________________________
____________________________________________________________________________________________
Monetary Policy _____________________________________________________________________________
____________________________________________________________________________________________
CYU 28-1, 1. a. _____________ b. ______________ c. _______________ d. _______________ e.
______________
Aggregate Supply – Between the years 1929 and 1933, economists have concluded that the U.S. economy was
moving down along the _______________ _____________ curve. This means that the economy was
experiencing __________________ price levels, ____________________ GDP and _____________________
unemployment.
The Short-Run Aggregate Supply Curve – The period between 1929 and 1933 revealed something dramatic
about the nature of our economy. This is THE insight that changed the field of macroeconomics. Brace
yourself.
There is a _________________ relationship in the short-run between price level and output. That was it.
How do you feel? Shocked? Rattled? Emboldened? Perhaps none of these (yet). Two results are worth
noting before we move on. The short run matters. Since gov. has a lot of control of PL, all sorts of tinkering
could be justified.
So why do higher prices drive higher production in the short run?
_______________________________________
____________________________________________________________________________________________
Explain the concept of sticky wages. How do sticky wages ensure that the AS curve is upward sloping?
____________________________________________________________________________________________
____________________________________________________________________________________________
Shifts of the Aggregate Supply Curve - Describe how each of the following can cause a shift in the AS curve.
Changes in commodity prices ___________________________________________________________________
____________________________________________________________________________________________
Changes in nominal wages _____________________________________________________________________
____________________________________________________________________________________________
Changes in productivity _______________________________________________________________________
____________________________________________________________________________________________
CYU 28-2, 1. a. __________________________ b. __________________________ c.
_______________________
Problem 3. a.
b.
4. a. ____________________ b. ____________________ c. _____________________ d.
____________________
Chapter 28: Aggregate Demand and Aggregate Supply – page 2
The Long-Run Aggregate Supply Curve – Wages are “sticky” in the short run, but flexible in the long run.
Explain why this is.
____________________________________________________________________________
Aggregate price level has no effect on GDP in the long run. Explain.
____________________________________
____________________________________________________________________________________________
Because all prices are flexible in the long run, including inputs, the LRAS curve is
_________________________.
This indicates that in the long run, even if prices change, GDP is
_______________________________________.
The LRAS curve connects with the x-axis at a point labeled Yp called ____________________
_______________.
This is the point at which the economy would produce if
______________________________________________.
As the economy grows over time (as represented in Figure 28-8), the LRAS curve shifts to the
________________.
From the Short Run to the Long Run - Make a note that when the X formed by the AD & AS curves does not
intersect on the LRAS curve, the economy is either operating above or below __________________. The
economy is experiencing some combination of unnatural levels of employment and/or inflation/deflation that
may need to be addressed through monetary or ___________ policy. These policies impact the AD curve by
stimulating or limiting demand. When the economy moves back to potential through a shift in the SRAS
curve, the variable that typically adjusts is ________________ ______________. When the economy is
operating below potential, nominal wages will __________, and when it operating above potential, nominal
wages will _________.
CYU 28-2, 1. a. _________________________ b. _________________________ c.
_________________________
2. __________________________________________________________________________________________
p. 764 pr. 5
The AD-AS Model – The AD-AS Model is helpful in determining __________________________________.
Short-Run Macroeconomic Equilibrium – The point at which the AD and AS curves intersect is referred to as
_________________________________. This represents the short run equilibrium ________ and
___________.
In this model, a fall in output of price does not mean they are declining, the increase is just below
______________.
Shifts of Aggregate Demand: Short-Run Effects – Shifts in the AD curve are caused by ___________
__________.
A negative demand shock causes _______ PL _______ GDP. A positive one causes ______PL and ______
GDP.
Shifts of the SRAS Curve - Shifts in the SRAS curve are caused by ___________ __________. A negative
supply shock causes _______ PL _______ GDP. (Ah! Stagflation!) A positive one causes ______PL and
______ GDP.
Demand shocks cause PL and GDP to move in the ______ direction, whereas supply causes them to move in
__________ directions. Governments have more control over the ____ curve than they do over the _______
curve.
Pr. 7. Rank – 1.
2.
3.
4.
Explain –
Long-Run Macroeconomic Equilibrium - When there is a negative demand shock, the difference between the
short-run equilibrium and the LRAS curve is referred to as a ______________________ ________. The main
problem this shock causes is high ________________________. If no government policy is applied, wages will
_______, SRAS will shift _____________ and the economy will return to _________________ in the long run
at a lower _______ ________. If AD is restored, the economy returns to _____________ a the old _______
________.
When there is a positive demand shock, the difference between the short-run equilibrium and the LRAS curve
is referred to as an __________________ ________. The main problem this shock causes is high
_______________. If no government policy is applied, wages will _______, SRAS will shift ___________ and
the economy will return to _________________ in the long run at a higher _______ ________. If AD is
reduced, the economy returns to _____________ a the old _______ ________. Note that restoring or reducing
AD can be induced by the g______
Recessionary and inflationary gaps are both called ____________ gaps. Output gaps tend to move toward
_____.
Because of this, we say the economy is ______-_______________. AD shocks affect the economy only in the
_______ ______. Describe supply shock recessions since World War II. Why are they so nasty?
______________
____________________________________________________________________________________________
CYU 28-3, 1. a. SRAS shifts right, PL – up, GDP -- ______ b.
_________________________________________
c. ____________________________________________
d. __________________________________________
Pr. 8. a. ________________________________________ b. __________________________________________
c. ____________________________________________
11. a.
d. __________________________________________
b.
c.
d.
Chapter 28: Aggregate Demand and Aggregate Supply – page 3
Macroeconomic Policy – In the long run, the economy is self-correcting, meaning it trends back toward
_______________ ______________. Economists have concluded this can take how long?
___________________
Because self-correction takes a long time, most economists recommend the government use
__________________ and _____________ policy to return the economy to __________________
________________. These policies are called _______________________ policies, and they impact the
_________________ ______________ curve.
These policies (are / are not) often effective in returning the economy to potential faster than self-correction
would.
Policy in the Face of Demand Shocks – What two policy goals would be achieved if the government were to
react immediately to negative demand shocks?
___________________________________________________________
Since policy makers are not perfectly informed, they should be cautious in acting to correct negative AD
shocks. Why?
_______________________________________________________________________________________
Should policy makers respond to positive AD shocks that increase productivity and price levels? _______ In
the U.S., we normally rely on monetary policy in such a case. How would monetary policy work to shift AD
to the left?
____________________________________________________________________________________________
Responding to Supply Shocks – There is no one appropriate response to a negative supply shock. Why is this?
____________________________________________________________________________________________
____________________________________________________________________________________________
Is Stabilization Policy Stabilizing? Has stabilization policy – applied in the U.S. since World War II – been
stabilizing to the U.S. economy?
_________________________________________________________________
____________________________________________________________________________________________
12. Draw the graphs with all labels presuming a self-correcting economy.
a.
b.
14. a. __________________ b.
___________________________________________________________________
b.
c.
d. __________________________________________________________________________________________
Chapter 28 – Review
Slope of the AD curve? _________________ SRAS curve? ________________ LRAS curve?
________________
Reasons for the Slopes of the Curves:
Wealth Effect –
Interest Rate Effect –
Sticky Wages –
Self-Correcting Economy –
Movements along the AD or SRAS curve are caused by changes in ______________ ______________.
List the factors that can shift the AD curve.
List the factors that can shift the SRAS curve.
List the 3 factors that shift the LRAS curve (chapter 25).
List examples of fiscal policy that would shift the AD curve right.
Which of the following affects AD directly – government purchases of goods and services or government
transfers?
Describe how monetary policy would shift the AD curve left.
What is the impact of the following on GDP, PL, and unemployment? AD shifts right:
AD shifts left:
SRAS shifts right:
SRAS shifts left:
Define: potential output –
Recessionary gap –
Inflationary gap –
Stagflation –
Stabilization policy –
Stabilization policy is effective to address ________________ shocks, but not ________________ shocks.
1) Draw the AD-AS model with a recessionary
2) Draw the AD-AS model with an inflationary gap
gap form a negative AD shock.
from a positive AD shock.
What stabilizing options does the government have in case 1? Case 2?
Why are there not good options for the government to address a recessionary gap resulting from stagflation?