econ104examreview - Econ 104 Exam 3 Review Test Wednesday...

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Econ 104: Exam 3 Review Test: Wednesday 12/18 Chapter 13 LRAS: identifies output at potential (full employment) o Shifts Change in resource base Change in number of workers Change in size of capital stock Technological change/innovation SRAS: upward sloping o As the price level increase, the quantity of goods and services firms are willing to supply increases o Why is SRAS upward sloping? Input prices (e.g. wages) are sticky Suppose demand increases in US economy: this increases the price of products, but input costs are slow to adjust o Profits and revenues will increase, so you have an incentive to increase output o Remember profit = revenues – costs So, when prices rise in the SR from CPI = 100 to CPI = 110, firms produce more output because input prices are sticky Menu prices As demand increases, firms may not increase their prices due to menu costs o Menu costs: the costs to firms of changing prices o Conclusion: a rising price level leads to a larger quantity of goods and services supplied Shifts in SRAS o 1. An unexpected change in the price of an important natural resource Ex/ An increase in the price of oil (supply shock) SRAS shifts leftward because firms cut production Y-bar decreases and unemployment increases Prior to the Great Recession, there was a surging demand for oil by developing economies: China India: and oil suppliers were weak/stagnant o 2. Increase in the labor force and/or capital stock o 3. Technological change Increases productivity o 4. An increase in the expected future price level
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Workers and firms increase wages and prices, so supply curve shifts left o 5. Workers and firms adjustment to errors in past expectations about the price level If underestimated price level, workers and firms increase wages and prices, so supply curve shifts left The US Economy in the LR and SR: A Supply Shock (negative) o Price of oil increase, so SRAS shifts left to SRAS2, creating a shortage o Price level increases so quantity demanded decreases putting us at point B—the SR equilibrium (intersection of SRAS2 and ED) where we have stagflation (rising U, falling Y, rising P) Stagflation is a combination of inflation & recession o Automatic adjustment- no policy intervention With rising unemployment, workers are willing to accept lower wages Decrease in input price of wages causes SRAS2 to shift back towards its original position at o Point A = LR equilibrium (where SRAS, LRAS, and AD intersect) How can an oil price shock cause a recession? o 1973-74 oil embargo by OPEC o 2003-2008 rapid increase in oil prices, especially 07-08 Conclusions: Impact of Oil Price Shock o Oil price shock is negative shock o SR equilibrium—stagflation o LR equilibrium is restored due to flexible wages & prices o The adjustment from B to A may take many years o Alternative: monetary and/or fiscal policy to restore o Where LRAS = SRAS = AD we have full employment The Internet (technological innovation) o
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