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 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 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 LRAS2 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 demand for their goods will rise cheaper which will increase sales revenues profits and produce incentive to increase production i e move up along SRAS curve 8 Which of these factors would result in a shift in the SRAS a increase the size of the labor force and the size of the capital stock b technological change c expected changes in the future price level d adjustments of workers and firms to errors in past expectations about the price level e supply shock 9 Draw a graph of the LR macroeconomic equilibrium where AD LRAS SRAS at price level equals 100 and output at potential Y bar Label the axes Explain 10 Starting from LR equilibrium in no 9 above show how a leftward shift in AD or SRAS can cause a recession a describe the economy s automatic adjustment mechanism back to Y bar At the new LR equilibrium is the price level higher or lower than P 100 lower price level in LR no change in output in LR in SR output falls below Y bar Y2 Y bar this adjustment from E to C will take time b in which case do we have stagflation Price level P increases Y real GDP decreases from Y bar to Y2 recession increase U stagflation combination of falling output recession increase U and rising prices 11 Starting from LR equilibrium in no 9 show how a rightward shift in AD can be cause an inflationary situation a describe the economy s automatic adjustment mechanism back to Y bar At the new LR equilibrium is the price level higher at lower than P 100 12 Define GDP gap Is the gap positive or negative when the U S is in recession Real GDP Gap actual GDP Y bar potential GDP actual 13 16 trillion potential 14 51 trillion recession like in 2008 Gap 0 actual GDP Y bar inflationary boom expansion U S trying to produce beyond Y bar or PPF 13 The White House and Congressional Budget Office forecast the U S will return to potential in 2014 14 What is the dynamic AD AS model Why are AD LRAS and SRAS usually shifting rightward over time Empirically we know 1 Y bar potential output increase continually LRAS is shifting rightward 2 AD is also shifting rightward during most years 3 SRAS shifting rightward except for years when workers firms are asking for higher wages prices supply shocks negative LRAS shifts rightward because Y bar increases due to increase U S Labor Force increase capital stock technological progress innovation SRAS shifts rightward because same factors that cause increase LRAS increase U S Labor Force increase capital stock technological progress innovation Chapter 14 text pages 456 463 464 473 Chapter 15 text pages 492 497 499 501 Chapter 16 pages 532 538 540 546 Lectures 4 4 4 23 15 Why did the American public decide they needed a central bank What is a bank panic When was the Federal Reserve the Fed created Does the Fed have a centralized or decentralized structure after several bank panics in 19th century Americans recognized the need for a leader of last resort to ensure the safety of the banking system 1913 Federal Reserve Act created Federal Reserve System which has a very unique structure 12 Federal Reserve Regional Banks a highly decentralized system designed to function as 12 separate cooperating CB s Fed was mainly created to avoid banking crisis panics How Fed would serve as leader of last resort lend funds to private banks during emergencies to avoid insolvency e g major crop failure farmers cannot make payments on loans 16 Why is the Federal Reserve referred to as a lender of last resort to ensure the safety of the banking system 17 What are the duties of