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U.S. Great Depression
- Began 1929 lasted 10 years
- Output fell 30%
- Unemployment rose to 25%
- Led to emphasis on short-run and demand side of economy
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Classical Economics
- Focused on long-run issues
- "invisible hand"
- Economy always return to potential output and target employment
- Laissez-faire
- Blamed depression
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Keynesian Economics
- Problems of depression requred short-run rather than long-run
- Adjustments to equilibrium for single market and aggregate economy are different
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Keynesian Economics
- Equilibrium income fluctuates
- Paradox of thrift: long run-saving leads to investment and growth
- short run-saving lead to decrease in spending, output, employment
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Aggregate Demand Curve
Relates changes in the price level with changes in aggregate expenditures, which are consumption, investment, gov spending and net exports.
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Short-Run Aggregate Supply Curve
Shows how a shift in AD affects the price level and real output in short-run
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Long-Run Aggregate Supply Curve
shows output that an economy can produce at full employment of labor and capital
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Shifts in AD Curve
- Foreign Income
- Exchange Rates
- Expectations
- Distribution of Income
- Government AD Management Policies
- Fiscal Policy
- Monetary Policy
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Short Aggregate Supply Curve to Shift
- Input prices
- Expectations
- Sales and excise taxes
- Productivity
- Import Prices
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Long Aggregate Supply Curve
- independent of level of price level
- depends on potential output
- Depends on capital, resources, growth-compatible insititutions, technology, and entrepreneurship
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Why a falling price level increases aggregate expenditures
- Wealth effect
- interest-rate effect
- international effect
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Wealth effect
a fall in the price level will make holders of money and of other finanical assets richer, so they buy more
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INterest Rate Effect
the effect that a lower price level has on investment expenditures thru the effect that a change in the price level has on interest rates
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International effect
as price level falls net exports will rise
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Multiplier effect
amplification of initial changes in expenditures
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Recessionary Gap
amount by which equilbrium output is below potential output
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Inflationary Gap
aggregate expenditures above potential output that exist at current price level
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Fiscal Policy
deliberate change in either government spending or taxes to stimulate or slow down economy
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Expansionary Fiscal Policy
increase the deficit by decreasing taxes or increasing gov. spending
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Contractionary Fiscal Policy
decrease the deficit by increasing taxes or decreasing govern. spendingMacro Policy more complicated thant it looks
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Macro policy is more complicated than it looks
- 1. implementing fiscal policy is slow legislative process
- 2. have no way of measuring potential output
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Most economists agree that fiscal policy
cannot be used to fine tune the economy
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An increase in aggregate demand
does not change potential output
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During Reagan Administration tax rates were reduced significantly, while federal defense spending rose by 80 percent. The effect of these policies on the AD curve:
Shows a shift to the left
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An economy's resources
can be over-utilized, but only temporarily
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Contractionary fiscal policies are most appropriate when the economy is in
an inflationary gap
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If actual output exceeds potential output, the economy
is experiencing an inflationary gap
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The rapid development of internet technologies during 1990s allolwed businesses to produce goods and services cheaper than. We would show this change in the aggregate-demand/aggregate-supply model by moving the aggregate
supply curve down (to the right)
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During 2005-2007, oil prices rose rapidly and reached historic highs. How would most economists predict these high prices should affect the U.S. economy in terms of the AD/AS model
because oil is an important input in many production processes, the higher prices would shift the short-run aggregate supply curve up (to the left.)
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Keynes believed equilibrium ouput (income) was:
not fixed at the economy's potential income
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A fiscal policy that increases gov. spending or cuts taxes is most appropriate when economy is in
a recessionary gap
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According to short-run aggregate supply curve, the response to an increase in aggregate demand is an increase in:
Both production and prices
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The classical economists argued that
if unemployment occurs it will not persist because wages and prices iwll fall
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Expansionary monetary policy will likely
shift the AD curve out to the right
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An increase in the aggregate demand curve will in the long run change
the price level but not output
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In 2009 the dollar depreciated sharply against foreign currencies. The dollar's depreciation should result in
an increase in U.S. exports and an outward shift of the U.S. aggregate demand curve
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The short-run aggregate supply curve is most likely to shift dow (to the right) if
input prices fall
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Fiscal policy is
difficult to enact but may help restore full employment
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Under what circumstances is it most clear the government should pursue neighter fiscal nor monetary policy
there is no inflation and the unemployment rate equals the target rate of unemployment
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What effect occurs because as prices fall, people become richer, so they buy more?
wealth effect
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