Ch08 - CHAPTER CHECKLIST When you have completed your study...

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When you have completed your study of this chapter, you will be able to C H A P T E R C H E C K L I S T Sketch the aggregate supply-aggregate demand ( AS-AD ) model and explain how real GDP and unemployment fluctuate in a business cycle. 1 Explain the forces that determine potential GDP and the functional distribution of income between labor and other factors of production. Explain what creates unemployment when the economy is at full employment and describe the influences on the natural unemployment rate. 2 3
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Macroeconomists divide the variables that describe macroeconomic performance into two lists: Real variables Nominal variables When the economy is operating at full employment , the forces that determine the real variables are independent of those that determine the nominal variables. Away from full employment , real and monetary forces interact to bring economic fluctuations. UNDERSTANDING MACROECONOMIC PERFORMANCE
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8.1 THE AS-AD MODEL The forces that determine potential GDP provide the anchor around which real GDP fluctuates in a business cycle. The AS-AD model explains the fluctuations around potential GDP. This is a very broad, metaphor-like, model, that gives us a story with which to understand the macroeconomy’s behavior. The AS-AD model has three components: Aggregate supply Aggregate demand
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8.1 THE AS-AD MODEL Aggregate Supply Potential GDP Potential GDP is the level of real GDP that the economy would produce if it were at full employment.
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8.1 THE AS-AD MODEL Aggregate supply The relationship between the quantity of real GDP supplied and the price level when all other influences on production plans remain the same. Other things remaining the same, the higher the price level, the greater is the quantity of real GDP supplied, and the lower the price level, the smaller is the quantity of real GDP supplied.
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8.1 THE AS-AD MODEL Each point A through E on the AS curve corresponds to the row identified by the same letter in the schedule.
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8.1 THE AS-AD MODEL Potential GDP is $10 trillion and when the price level is 110, real GDP equals potential GDP.
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8.1 THE AS-AD MODEL If the price level is above 110, real GDP exceeds potential GDP.
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8.1 THE AS-AD MODEL If the price level is below 110, real GDP is less than potential GDP.
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8.1 THE AS-AD MODEL Changes in Aggregate Supply Aggregate supply changes when potential GDP changes. As potential GDP increases, aggregate supply increases and the AS curve shifts rightward. Aggregate supply also changes when the money wage rate or any other input cost in money terms, such as the price of oil, changes. A rise in the money wage rate or in the price
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8.1 THE AS-AD MODEL Aggregate Demand Aggregate demand The relationship between the quantity of real GDP demanded and the price level when all other influences on expenditure plans remain the same.
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