sg09 - 9 Aggregate Demand and Aggregate Supply Chapter...

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9 Aggregate Demand and Aggregate Supply Chapter Summary Aggregate demand and aggregate supply analysis helps explain relationships between price levels and output. Here are the main points of the chapter: Because prices are sticky in the short run, economists think of GDP as being determined primarily by demand factors in the short run. The aggregate demand curve depicts the relationship between the price level and total demand for real output in the economy. The aggregate demand curve is downward sloping because of the wealth effect, the interest rate effect, and the international trade effect. Decreases in taxes, increases in government spending, and increases in the supply of money all increase aggregate demand and shift the aggregate demand curve to the right. Increases in taxes, decreases in government spending, and decreases in the supply of money all decrease aggregate demand and shift the aggregate demand curve to the left. In general, anything (other than price movements) that increases the demand for total goods and services will increase aggregate demand. The total shift in the aggregate demand curve is greater than the initial shift. The ratio of the total shift in aggregate demand to the initial shift in aggregate demand is known as the multiplier. The aggregate supply curve depicts the relationship between the price level and the level of output firms supply in the economy. Output and prices are determined at the intersection of the aggregate demand and aggregate supply curves. The long-run aggregate supply curve is vertical because, in the long run, output is determined by the supply of factors of production. The short-run aggregate supply curve is fairly flat because, in the short run, prices are largely fixed, and output is determined by demand. Supply shocks can shift the short-run aggregate supply curve. The short-run aggregate supply curve shifts in the long run, restoring the economy to the full- employment equilibrium. Applying the Concepts After reading this chapter, you should be able to answer these three key questions: 1. What does the behavior of prices in retail catalogs demonstrate about how quickly prices adjust in the U.S. economy?
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128 Chapter 9 2. How can changes in demand cause a recession? In particular, what factors do economists think caused the 2001 recession? 3. Do changes in oil prices always hurt the U.S. economy? 9.1 Sticky Prices and Their Macroeconomic Consequences What causes economic fluctuations? The price system serves as a coordinating mechanism in the economy. When prices and wages are flexible and adjust quickly, prices signal to markets what should and should not be produced. Equilibrium is restored and resources are efficiently allocated to their best use. But what if prices are not flexible and don’t adjust quickly? That is the issue with sticky prices. Sticky prices happen when prices don’t immediately adjust to changing market conditions.
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sg09 - 9 Aggregate Demand and Aggregate Supply Chapter...

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