econ 104 final review - Review Questions for Final Exam...

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Review Questions for Final Exam Chapter 13, Lectures 3/14 – 4/2 1. Define aggregate demand (AD). What is the equation for AD? Aggregate demand (AD) shows the relationship between the price level and the quantity of real GDP demanded by HH’s (C), firms (I), Government (G), and foreigners (NX). AD = C + I + G + NX 2. Why does AD have a negative slope? In other words, when the price level rises or falls, how are C, I, NX affected? AD has a negative slope because: 1. Wealth Effect: as the price level rises, wealth decreases and C decreases 2. Interest Rate Effect: nominal interest rates = real rate + inflation; i increases = r + Π increases i rates increase because as price level rises, HH’s and firms need more money to finance buying and selling; to obtain more money: borrow more, sell financial assets, withdraw funds from bank; increase demand for money increase i decrease C and decrease I 3. NX Effect: as price level increases, imports (m) increases, exports (x) decreases, NX (net exports) decrease 3. What is monetary policy to stabilize the economy during recession? During inflationary boom? AD shifts right; I moves downward; C increases AD increases = C increases + I increases + G + NX at every price level, AD is higher (rightward shift in AD) 4. What is fiscal policy to stabilize the economy during recession? During inflationary boom? Congress can decreases taxes (T) and/or increase expenditures (G) C moves upward; I shifts right; AD shifts rightward AD = C increases + I increases + G increases + NX 5. Define long-run aggregate supply (LRAS). What determines the level of LRAS? Why do we say LRAS is potential GDP or full employment output? Long Run Aggregate Supply (LRAS): indicates the level of potential full employment output for the economy 1. Y bar represents potential output when U.S. is on PPF 2. Is vertical, i.e. Change in Price level has no effect on LRAS LRAS is determined by: 1. # of workers 2. The capital stock (i.e. # of factory buildings, technology that is available, machines, software, etc.) 6. How would an increase in the size of the US work force, an increase in the U.S.
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capital stock or an advance in technology affect the LRAS curve? LRAS: typically shifts every year ( Y bar increases) – why? 1. # of laborers increases 2. Technological change or innovation occurs (increase output/hr = increase productivity) 3. Size of the capital stock increases every year * if all 3 increase, LRAS shifts right to LRAS 2 7. Define short-run aggregate supply (SRAS). Why does the SRAS have a positive slope? Short Run Aggregate Supply (SRAS): shows the effect of changes in the price level on the quantity of goods/services. Firms are willing and able to produce - as price level (P) rises, the quantity of goods/services firms are willing to supply increases SRAS has a positive slope because: 1. Output prices rise faster than input prices; inputs = labor, raw materials, etc. Sales revenues will increase faster than cost of inputs profits = sales or revenue – costs increase willingness of firms to produce more output (move up along SRAS function) 2. Some firms will not increase output prices as the price level rises
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