ECON 201 1st Edition Exam #3 Study Guide- Aggregate demand and aggregate supply model- a model that explains short-run fluctuations in real GDP and the price level- Aggregate demand and aggregate supply- in the short run, real GDP and the price level are determined by the intersection of the aggregate demand curve and the short run aggregate supply curve- Real GDP is measured on the horizontal axis and the price level is measured on the vertical axis by the GDP deflator- GDP deflator: nominal GDP/Real GDP X 100- Aggregate demand curve- a curve that shows the relationship between the price level and the quantity of real GDP demanded by households, firms, and the government- If price is higher, total value higher- Short run aggregate supply curve- a curve that shows the relationship in the short run between the price level and the quantity of real GDP supplied by firms- Y(GDP)=C(consumption)+I(investment or S)+G(government spending)+NX(net exports)- The aggregate demand curve is sloping downward because a fall in the price levelincreases the quantity of real GDP demanded- Some of a household’s wealth, the difference between the value of its assets and the value of its debts, is held in cash or other nominal assets that lose value as the price level rises and gain value as the price level falls- Wealth effect- when the price level falls, the real value of household wealth rises, and so will consumption and the demand for goods and services- Look up GDP formula for extra practice- Nominal GDP- total value- Real GDP- use the base year- Real GDP in base year is the same as nominal- The wealth effect- how a change in the price level affects consumption- The interest rate effect- how a change in the price level affects investment- The international-trade effect- how a change in the price level affects net exports- A higher price level increases the interest rate and reduces investment spending, thereby reducing the quantity of goods and services demanded- A lower price level will decrease the interest rate and increase investment spending, thereby increasing the quantity of goods and services demanded, aka interest rate effect- Net exports equal spending by foreign households and firms on goods and services produced in the US minus spending by US households and firms on goods and services produced in other countrieso A higher price level in the US relative to other countries causes net exportsto fall, reducing the quantity of goods and services demandedo A lower price level in the US relative to other countries causes net exports to rise, increasing the quantity of goods and services demanded through the international trade effect- The aggregate demand curve tells us the relationship between the price level and the quantity of real GDP demanded, holding everything else constant- The variables that cause the aggregate demand curve to SHIFT-o Changes in government policieso Changes in expectations of households and firmso Changes in foreign variables- Changes in government policies- o Monetary policy- the actions the federal reserve takes to manage the money supply and interest rates to pursue macroeconomic policy objectiveso Fiscal policy- changes in federal taxes and purchases that are intended to achieve macroeconomic policy objectives- Changes in expectations of households and firms- if households become more optimistic about their future incomes, they are likely to increase their current consumption- Changes in foreign variables- if firms and households in other countries buy fewerUS goods or if firms and households in the US buy more foreign goods, net exports will fall, and the aggregate demand curve will shift to the left- Money supply is determined by the federal reserve- Interest rate is determined by demand and supply meeting(money market)- Example of shifts in the AGGREGATE DEMAND CURVE:An increase in: Shifts the aggregate demand curve: Because:Interest rate Left Higher interest rates raise the costs to firms and households of borrowing, reducing consumption and investment spendingGovernment purchases Right Government purchases are acomponent of aggregate demandPersonal income taxes or business taxesLeft Consumption spending fallswhen personal taxes rise, and investment falls when business taxes rise Households expectations of their future incomesRight Consumption spending increases Firms expectations of their future probability of investment spendingRight Investment spending increasesThe growth rate of domesticGDP relative to the growth rate of foreign GDPLeft Imports will increase faster than exports, reducing net exportsThe exchange rate(the valueof the dollar) relative to foreign currenciesLeft Imports will rise and exports will fall; reducing net exports- The short run aggregate supply curve- the 3 most common explanations as to whya short run aggregate supply curve slopes upward includes:o Contracts make some wages and prices stickyo Firms are often slow to adjust wageso Menu costs make some prices sticky Menu costs- the costs to firms of changing priceso Difference in moving and shifting in aggregated demand curve When price level changes, GDP changes, this is called movement Demand can also be affected by other things. What factor shifted it? Policy changes it, household expectations, firms’ expectations, and foreign variables. Shifting is when real GDP demand changes, but not price level- Monetary policy with SRAS- an increase in supply in money market(decrease interest rate), makes an increase in investment in GDP which shifts aggregated demand curve to the right, and vice versa- Fiscal policy with SRAS- government changes other variables which end up changing aggregated demand and vice versa- Movement is enduced by price level changing - Shifting is by other things changing, price level doesn’t change- Variables that shift the short run aggregate supply curve:o Increases in the labor force and in the capital stocko Technological changeo Expected changes in the future price level- The SRAS curve shifts to reflect worker and firm expectations of future prices If workers and firms expects that the price level will rise by 3% from 100 to 103, they will adjust their wages and prices by that amount Holding constant all other variables that affect aggregate supply, the short run aggregate supply curve will shift to the left If workers and firms expect that the price level will be lower in the future, the short run aggregate supply curve will