hw6 - ECON103A Discuss Session Grace Waner Gu T...

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Fri, Nov 16 Grace Waner Gu [email protected] CH9(6 th edition): i).QR2: Give an example of a price that is sticky in the short run and flexible in the long run. The price of a magazine is an example of a price that is sticky in the SR and flexible in the LR. Economists don’t have a definitive answer as to why magazine prices are sticky in the SR. Perhaps customers would find it inconvenient if the price of a magazine they purchase changed every month. ii). QR3: Why does the aggregate demand curve slope downward? AD is the relation b/w the quantity of output demanded and the aggregate price level. To understand why the aggregate demand curve slopes downward, we need to develop a theory of aggregate demand. One simple theory of aggregate demand is based on the quantity theory of money. Write the quantity equation in terms of the supply and demand for real balances as M/P=(M/P) d =kY ,where k=1/V. This equation tells us that for any fixed money supply M, a genitive relationship exists b/w the price level P and output Y, assuming that velocity V is fixed: the higher the price level, the lover the level of real balances and, therefore, the lower the quantity of goods and services demanded Y. In other words, the aggregate demand curve slopes downward. On way to understand this negative relationship b/w the price level and output is to note the link b/w money and transactions. If we assume that V is constant, then the money supply determines the dollar value of all transactions: MV=PY. An increase in the price level implies that each transaction requires more dollars. For the above identity to hold with constant velocity, the quantity of transactions and thus the quantity of goods and services purchased Y must fall. iii). QR4: Explain the impact of an increase in the money supply in the short run and in the long run. If the Fed increases the money supply, then the aggregate demand curve shifts outward. In the SR, prices are sticky, so the economy moves along the SRAS curve from point A to pint B. Output rises above its natural rate level Y1-the economy is in a boom/expansion. The high demand, however, eventually causes wages and prices to increase. This gradual increase in prices moves the economy along the new aggregate demand curve AD2 to point C. At the new LR equilibrium, output is at its natural rate level. But prices are higher than they were in the initial equilibrium at point A. iv). QR5: Why is it easier for the Fed to deal with demand shocks than with supply shocks?
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hw6 - ECON103A Discuss Session Grace Waner Gu T...

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