Ecn 204 Final Exam Notes

Macro Final Exam Chapter 10 The silver Systems What assets argon considered property? What atomic number 18 the functions of silver and the types of gold? * W/o specie, trade would require barter > Exchanging one intimately/service for a nonher(pre titular) * un likely occurrence that two people e/ rescue a good that other necessitates * 3 functions * Medium of deepen an item procureers hit to sellers when they want to purchase g/s * Unit of account the yardstick ppl hold to post wrongs &038 record debts * Store of value an item ppl support use to transfer acquire power from the present to the future * 2 kinds Commodity cash commodity with intrinsic value, i. e. gold coins * Fiat specie coin w/o intrinsic value, used as silver b/c of govt decree, i. e. vaulting horse bills * Money in pilen thrift * Money issue (Money stock) the measuring rod of bills operable in the preservation * Two assets should be considers * Currency the paper bills &038 coins in the hands of the command public * Demand deposits balances in stick accounts that despositors merchant ship access on penury by writing a stay/using debit card * Money Supply = currency + depositsWhat is the rely of footada and its role? How do tills create coin? * Central chamfer an presentation designed to regulate the money put out in the economy * Bank of fireada the aboriginal rely of stinkerada * Established in 1935, nationalized in 1938, stimulateed by potbellyn govt * Managed by board of directors ap accuseed by minister of Finance, composed of g everywherenor, the senior deputy g everywherenor (7 yr terms), 12 directors (3 yr terms) * Four primary functions * Issue currency, act as banker to commercialized-grade banks &038 dismissn govt, control money fork up * Commercial Banks and Money Supply Although Bank of crapperada alone is responsible for canisteradian monetary policy, the central bank can control the communicate of money only by means of its influence on the entire banking governing body * Commercial banks include quote unions, caisses populaires, and trust companies * Commercial banks can influence the metre of demand deposits in economy and money supply * Reserves cash that commercial banks asseve regularize * Fractional banking system > Keeps fraction of deposits as militia, rest is loaned * Banks whitethorn carry oftentimes than this minimum amt if they rent * The reserve ratio, R Fraction of deposits that banks look at as reserves * Total reserves as % of total deposits * Bank T-account * T-account simplified unseasoneds report statement that shows banks Assets &038 liabilities * Banks liabilities deposits(what we put in the bank), Assets Loans and reserves(What bank keeps) * R= Reserves/Deposits * Banks &038 money supply * $ degree centigrade of currency is in circulation, determining repair on money supply aim in 3 different cases * No banking system Public cave ins the $100 as currency M oney supply= $100 * 100% reserves banking system banks hold 100% of deposits as reserves create no loans * MS = Currency (loans) + deposits = 0 +100 = 100 * Bank does non make size of money supply * Fractional reserve banking system * R=10% Reserves 10, Loans 90, Deposits 100 * MS= $190 * When banks make loans > create money * Borrower gets 90 in currency(asset), 90 in sassy debt/loan (liability) * Money Multiplier The amt of money the banking system gene come ins with each vaulting horse of reserves * Money multiplier = 1/R R =10, 1/R = 10, 100 x 10 = 1000 * The Bank of Canadas tools of Monetary Control * 1. Open- merchandise place operations * When it buys govt bonds from/ sells to the public * Foreign ex deepen groceryplace operations when it buy/sells immaterial currencies * MS growing when bank of Canada buys foreign currency with Canadian Currency and decrease when BoC sells foreign currency * 2. Changing the overnight consec cast * Central banks act as bankers t o commercial banks Bank post by-line rank charged by bank of Canada on loans to the commercial banks * Since 1998 Bank of Canada as anyowed commercial banks to soak up freely at the bank swan, salaried commercial banks the bank rate, minus fractional percent, on their deposits at bank of Canada * Commercial banks neer need to take over much than bank rate for improvident term loans, b/c they can ever borrow from the Bank of Canada kinda * Conversely, commercial banks never need to accept less than the bank rate, minus half a percent, when they make short loans, be fix they can always lend to the bank of Canada instead * everywherenight rate the enkindle rate on very short-term loans betwixt commercial banks * Bank of Canada can alter the money supply by changing the bank rate, which in turn causes an equal change in overnight rate * A high bank rate discourages commercial banks from borrowing from the Bank of Canada * A higher overnight rate discourages commerci al banks from borrowing from other commercial banks * An maturation in the overnight rate reduces the quantity of reserves in the banking system, which in turn reduces the money supply * Bank of Canadas control of MS is not skillful * Bank of Canada must wrestle w/ 2 problems that come from fractional-reserve banking * Does not control amt of money that * Household choose to hold as deposits in banks * Commercial bankers choose to lend Chapter 11 Money Growth and pretentiousness How does the money supply fall the lump &038 titular concern range? * measurement theory of money hurt cuts when govt prints too very much money * Most economists believe the quantity theory is a good explanation of the prospicient run behavior of raise prices * Asserts that quantity of money specifys value * 2 approaches * Supply demand diagram MS intractable by bank of Canada, banking system, consuers * In feign, assume that BoC precisely controls MS &038 sets it at few fixed amt * MD (m oney demand) how much riches ppl want to hold in liquid form * Depends on P an maturation in P reduces the value of money, so more money is required to buy goods &038 services * Thus Quantity of money demanded is vely related to the value of money +vely related to P, other things equal ( unfeigned income, affaire rates, availability of ATMs) * * Results from Graph change magnitude MS causes P to reverse * How does this work? Short version * AT the initial P, an increase in MS causes excess supply of money * People get rid of their excess money by spend it on goods &038 services/ by loaning it to others who spent it * Result increase demand of goods But supply of goods does not increase, so prices must rise * Other things happen in the short run, which we will study in later chapters) * equality * Nominal Variables argon c arful in monetary units * i. e. Nominal gross internal product, nominal interestingness rates (rate of return mensurable in $) nominal lock($ per/hour w orked) * Real Variables are measured in corpo accredited units * i. e. corpo in truth GDP sure interest rate (measured in output) factual wage (measured in output) * Real vs. Nominal * Prices are normally measured in terms of money * Price of a compact disc $15/cd * Price of a pepperoni pizza pie $10/pizza A comparative price price of one good congress (divided by) another * intercourse price of CDs in terms of pizza * Price of CD/Price of pizza = 15/10 = 1. 5 pizzas per cd * Relative prices are measured in physical units so they are literal variables * Real vs. Nominal Wage * An important sexual relation price is the authorized wage * W= nominal wage= price of labor movement $15/hr * P = price level = price of g&038s $5/unit of output * Real wage is price of childbed sex act to price of output * W/P = 15/5 = 3 units output per hour * Classical theory of pomposity * Increase in boilersuit level of prices * everyplace past 60 yrs, prices risen on avg of 4%/yr Deflation people will clutch for prices to drop on big ticketed items, dropped in the 20th century * In 1970s prices arise by 7%/yr * During 1990s, price rose at 2%/yr * Hyper rising prices extraordinary high rate * Quantity theory of money explain long-run determinants of price lvl and ostentation rate * Inflation is an economy-wide phenomenon that concerns the value of the economys medium of substitution * When the overall price level rises, value of money come abouts * Inverse family relationship b/w price &038 value of money * Value of money * P = Price lvl (CPI/ GDP deflator) * P = price of basket of goods measured in money * 1/P is value of $1, measured in goods * Example basket contains one candy bar, P = $2, Value of $1 is ? candy bar * The Classical Dichotomy Classical dichotomy suppositious separation of nominal &038 real variables * Hume &038 the unsullied economists suggested that monetary developments affect nominal variables but not real variables * If the central bank d oubles the MS, Hume &038 classical thinkers contend * All nom variables (including prices) will double * All real variables (Including relative prices) will remain unvaried * The neutrality of Money * Monetary neutrality the proposition that changes in the MS do not affect real variables * Doubling money supply causes all nominal prices to double, what happens to relative prices? * Initially, relative price of cd in terms of pizza is * Price of cd/price of pizza = 15/10 = 1. pizzas per cd * After nominal prices double * 30/20 = 1. 5 pizza per cd * Relative price is unchanged * Monetary neutrality proposition that changes in the MS do not affect real variables * Similarly, the real wage W/P remains unchanged, so * Quantity of labour supplied/demanded, total utilisation does not change * The same applies to purpose of capital &038 other resources * Since employment of all resources in unchanged, total output is as well unchanged by the MS * Most economists believe the classical d ichotomy &038 neutrality of money describe the economy in the long run Does the money supply affect real variables like real GDP or the real interest rate? The velocity of Money the rate at which money changes hands * Notation * PxY = nominal GDP = price level x real GDP * M = money supply * V = velocity * Velocity formula V = PXY/M * Pizza, Y = real GDP = 3000 pizzas, P= price of pizza = $10, P*Y = $30,0000, M = $10,000 * V=30,000/10,000= 3, avg dollar bill was used in 3 executions * Quantity Equation * M*V = P*Y * V = stable * So, a change in M causes nominal GDP (P*Y) to change by the same % * A change in M does not affect Y money is neutral, Y is determined by tech &038 resources * So, P changes by the same % as P*Y and M * quick money supply growth causes rapid pomposity How is rising prices like a impose? Hyperinflation is generally defined as inflation transcend 50%/month * Excessive growth in the MS always causes hyperinflation * Inflation tax * When tax r veritable(a )ue is inadequate and ability to borrow is ltd, govt may print money to pay for its spending * more or less all hyperinflations start this way * The revenue from publish money is the inflation tax printing money causes inflation, which is like a tax on everyone who holds money * The Fischer Effect * Rearrange definition of real interest rate * Nominal interest rate = Inflation rate + real interest rate * Real interest rate is determined by frugality &038 investiture in the loanable funds mart * MS growth determines inflation rate This equation shows how the nominal interest rate is determined * In long run, money is neutral, so a change in the money growth rate affects the inflation rate but not the real interest rate * So, nominal interest rate adjusts one-for-one with changes in the inflation rate * The inflation tax applies to peoples holdings of money, not their holdings of chaplet * Fishcher onus an increase in inflation causes an equal increase in the nominal interest r ate, so the real interest rate is unchanged What are the cost of inflation? How serious are they? * The inflation hallucination most ppl think inflation erodes real income * Inflation is a general increase in price of the things ppl buy &038 the things they sell (i. e. labour) * In long run, real incomes are determined by real variables, not inflation rate * Shoeleather costs the resources wasted when inflation encourages ppl to reduce their money holdings * Includes the beat &038 movements costs of more frequent bank withdrawals * Menu costs the costs of changing prices Printing new placards, mailing new catalogs * Misallocation of resources from relative-price division Firms dont all raise prices the same time, so relative prices can vary which distorts the allocation of resources * Confusion &038 inconvenience inflation changes the yardstick we use to measure transactions, complicates long-range planning &038 the comparison of dollar amts over time * Tax distortions inflati on makes nominal income grow faster than real income, taxes are based on nominal income, &038 some are not adjusted for inflation, so inflation causes ppl to pay more taxes even when their real incomes dont increase * Arbitrary redistributions of wealth Higher-than- pass judgment inflation transfers purchasing power from creditors to debtors debtors get to repay their debt w/ dollars that arent worth as much * Lower-than-expected inflation transfers purchasing power from debtors to creditors * High inflation is more variable &038 less predictable than low inflation * So, these arbitrary redistributions are frequent when inflation is high * Costs are high for economies experiencing hyperinflation * For economies w/ low inflation ( 0, detonator out black merchandise place, national purchases of foreign assets sink foreign purchases of internal assets * chapiter is flowing out of country * When NCO < 0, Capital inflow, foreign purchases of house servant assets exceed domesti c help purchases of foreign assets * Capital is flowing into the country * Variables that Influence NCO * Real interest rates paid on foreign assets or domestic assets * Perceived risks of holding foreign assets * Govt policies affecting foreign ownership of domestic assets * The equality of NX &038 NCO * An accounting identity NCO = NX * Arises b/c every transactions that affects NX also affects NCO by the same amt (And vice versa) * When a foreigner purchases a good from Canada, * Cann exports &038 NX increase The foreigner pay w/ currency or assets, so the Cann acquires some foreign assets, causing NCO to rise * An accounting identity NCO=NX * Arises b/c every transaction that affects NX also affects NCO the same amt ( &038 vice versa) * When a Cann citizen buys foreign goods, * Cann imports rise, NX falls * The Cann buyer pays w/ Cann dollars or assets, so the other country acquires Cann assets, causing Cann NCO to fall * Saving, enthronisation, &038 international Flows of Good s &038 Assets * Y = C + I + G + NX accounting identity * Y C G = I + NX rearranging terms * S = I + NX since S = Y C G * S = I + NCO since NX = NCO * When S > I, the excess loanable funds flow afield in the form of positive net capital outflow, NCO >0 * When S e =P*/P implies that the nom flip rate between 2 countries should equal the ratio of price lvls * If the 2 countries have diff inflation rates, thusly e will change over time * If inflation is higher in Mexico than in Canada, Then P* rises faster than P, so e rises the dollar appreciates against the peso * If inflation is higher in Canada than in Japan, then P rises faster than P*, so e falls- the dollar depreciates against the yen * Limitations of PPP theory, why exchange rates do not always adjust to equalize prices across countries * M some(prenominal) goods cannot easily be traded * i. e. haircuts, going to movies * Price remainders on such goods cannot be arbitraged away * Foreign, domestic goods not perfect substitutes * i. e. some Cann consumers prefer Toyatos over Chevys * Price differences reflect taste differences * Nonetheless, PPP works well in many cases, especially as an explanation of long-run trends * i. e.PPP implies the greater a countrys inflation rate, the faster its currency should depreciate (relative to a low-inflation country like Canada) * Interest rate determination in a small open economy w/ perfect Capital mobility * why do interest rates in Canada &038 the U. S. tend to move up &038 down together? * Canada is a small open economy w/ perfect capital mobility * small = small part of the manhood economy * Canada is an economy w/ perfect capital mobility b/c * Canns have full access to field financial securities industrys, * And the rest of the world has full access to the Cann finl mart * This means that the real interest rate in Canada should equal the real rate playing in the world U. S. r= rw * Perfect Capital mobility theory that real interest rate in Canada should equal that in the rest of the world is known as interest rate parity * Limitations real interest rate in Canada is not always = to the real interest rate in the rest of the world b/c * Finl assets carry w/ them the casualty of default * Finl assets offered for sale in different Chapter 13 Macroeconomic theory of the open economy In an open economy, what determines the real interest rate? The real exchange rate? * Market of loanable notes S=I + NCO * Supply of loanable funds = frugality * A dollar of saving can be used to finance * The purchase of domestic capital * The purchase of foreign asset * So, demand for loanable funds=I + NCO * S count ons +vely on the real interest rate, r * I depends vely on r * Real interest rate, is the real return on domestic assets * A fall in r makes domestic assets less enthralling relative to foreign assets * Canns purchase more foreign assets * Canns purchase fewer domestic assets * NCO rises * The supply &038 demand for loanable funds depend on the real interest rate * A higher real interest rate encourages ppl to save &038 raises the quantity of loanable funds supplied * The interest rate adjusts to bring the supply &038 demand for loanable funds into balance * At eqm interest rate, the amt that ppl want to save on the button balances the desired quantities of domestic investment &038 foreign investment * Loanable funds grocery store diagram * R adjusts to balance supply &038 demand in the LF commercialize * Both I &038 NCO depend vely on r, so the D crook is downward-sloping * * In small open economy w/ perfect capital mobility, i. e. Canada, the domestic interest rate = world interst rate * As a result, the quantity of loanable funds made available by the savings of Canns does not have to equal the quantity of loanable funds demanded for domestic investment * The difference between these two amts is NCO * * How are the markets for loanable funds &038 foreign-currency exchange connected? The market for for eign-currency exchange exists b/c ppl want to trade w/ ppl in other countries, but they want to be paid in their own currency * 2 side of foreign-currency exchange market are stand for by NCO &038 NX * NCO represents the imbalance between the purchases &038 sales of capital assets * NX represents the imbalance b/w exports &038 imports of goods &038 services * Another identity from preceding chapter NCO = NX * In the market for foreign-currency exchange, * NX is the demand for dollars foreigners need dollars to buy Cann NX * NCO is the supply of dollars Cann residents provide/give dollars when they buy foreign assets * S=I + NCO > S I =NX * What price balances the supply &038 demand in the market for foreign-currency exchange? * The real exchange rate (E) = e*P/P* The Cann exchange rate(E) measures the quantity of foreign g/s that trade for one unit of Cann g/s * E is the real value of a dollar in the market for foreign-currency exchange * The demand slip for dollars (NX) is dow nward sloping b/c a higher exchange rate makes domestic goods more valuable * The supply curve (NCO) is vertical b/c the quantity of dollars supplied for NCO is misrelated to the real exchange rate * Increase in E makes Cann goods more expensive to foreigners, reduces foreign demand for Cann goods &038 dollars, does not affect NCO/supply of dollars * The real E adjusts to balance the S &038 D for dollars * At Eqm E, the demand for dollars to buy NX exactly balances the supply of dollars to be exchanged into foreign currency to buy assets abroad * Disentangling S&038D When cann resident buys imported goods does the transaction affect s/d in foreign exchange market? * The demand for dollars decrease * The increase in imports reduce NX which we think of as demand for dollars (NX= net demand for dollars) * When foreigner buys Cann asset, does the transaction affect supply/ demand in the foreign exchange market * The supply of dollars falls * NCO = Net supply of dollars How do govt fi gure deficits affect exchange rate &038 trade balance? * The effectuate of a budget deficit * National saving falls * The real interest rate rises * Domestic investment &038 net capital outflow both(prenominal) fall * The real exchange rate appreciates * Net export fall (or the trade deficit increases) * Eqm in the Open economy NCO is the variable that links these two markets S = I + NCO, NCO =NX * In the market for loanable funds, supply comes from national saving &038 demand comes from domestic investment &038 NCO * In the market for foreign-currency exchange, suplly comes from NCO &038 demand comes from BX * * * Eqm in the open economy * Prices in the loanable funds market &038 the foreign-currency exchange market adjust concurrently to balance supply &038 demand in these two markets * As they, they determine the largeeconomic variables of national saving, domestic investment, NCO, and NX How do other policies or events affect the interest rate, exchange rate, and trade bala nce? The magnitude &038 variation in important macroeconomic variables depend on the following * Increase in world interest rates * Govt budget deficits &038 surpluses * apportion policies * political &038 economic stability * cardinal steps in using the model to analyze these events * coif which of the s/d curves e/ event effects * Determine which way the curves shift * Examine how these shifts alter the economys equilibrium * * * Increase in world interest rates * Events remote Canada that cause world interest rates to change can have important effects on the Cann economy * In a small open economy w/ perfect mobility, an increase in the world interest rate * Crowds out domestic investment, * type NCO to increase &038 * Causes the dollar to depreciate * The effects of an increase in the govt budget deficit * * Govt budget deficits &038 surpluses * b/c a govt budget deficit represents negative public saving, it reduces national saving, and wherefore reduces * the supply of lo anable funds * NCO * The supply of Cann dollars in the market for foreign-currency exchange * Trade Policy is a govt policy that forthwith influences the quantity of goods services that a country imports/exports * Tariff a tax on imported goods * Imported quota a limit on quantity of a good produces abroad and sold domestically * Initial refer is on imports which affects NX NX are the sources of demand for dollars in the foreign-currency exchange market * Imports are reduced at any exchange rate, &038 NX will rise * This increases the demand for dollars in the foreign currency exchange market * * * There is no change in the market for loanable funds, and therefore, no change in NCO * B/c foreigners need dollars to buy Cann NX, there is an change magnitude demand for dollars in the market for foreign-currency * This leads to an wonder of the real exchange rate * Effect of an import quota * An appreciation of the dollar in the foreign exchange market discourages exports * This o ffsets the initial increase in NX due to import quota * Trade policies do not affect the trade balance Political imbalance &038 Capital Flight * Capital flight * Is large &038 sudden decrease in demand for assets located in a country * Has its largest impact on the country from which the capital is fleeing, but it also affects other countries * If investors locomote concerned about the safety of their investments, capital can quickly put up an economy * Interest rates increase &038 the domestic currency depreciates * When investors round the world observed political problems in Mexico in 1994, they sold some of their Mexican assets and used the proceeds to by assets of the other countries * This increased Mexican NCO An increased demand for loanable funds in the loanable funds market leads the interest rate to increase * This increased the supply of pesos in the foreign-currency exchange market * * Chapter 14 Aggregate Demand &038 Supply What are economic fluctuations? What are their characteristics? * Over LR, Real GDP grows about 2%/yr on avg * In SR, GDP fluctuates around its trend * Recessions fall real incomes &038 rising unemployment * Depressions severe recessions (very rare) * SR economic fluctuations are often called business cycles * 3 facts about economic fluctuations * Are irregular &038 unpredictable * Most macroc quantities fluctuate together * As output falls, unemployment rises Use mode of AD &038 AS to study fluctuations * Short run, changes in nominal variables (Ms or P) can affect real variables (Y/U-rate) How does the model aggregate demand &038 supply explain economic fluctuations? * Aggregate-demand curve shows the quantity of goods &038 services that households, firms, &038 the govt want to buy each price level * Aggregate-supply curve- shows the quantity of goods &038 services that firms choose to produce and sell at each price level * wherefore does the aggregate-demand curve slope downward? What shifts the AD curve? * AD curv e shows quantity of g/s demanded in the economy at any given P * Y=C+I+G+NX * apply G fixed by govt policy Increase in P reduces the quantity of g/s demanded b/c * The wealth effect (c falls) * The dollars ppl hold buy fewer g/s so real wealth is lower * Ppl feel poorer * i. e. a stock market boom makes households feel wealthier, C rises, the AD curve shifts the right way preferences consumption, saving tradeoff tax hikes/cuts * Interest rate effect (I falls) * Buying g/s requires more dollars * To get these dollars, ppl borrow more * Drives up interest rates * i. e. firms buy new computers expectations, optimism/pessimism Interest rates, monetary policy investment tax credit/other tax incentives * The exchange rate effect (NX falls) * Real exchange rate= exP/P* Increase real exchange rate, Cann exchange rate appreciates * Cann exports more expensive to ppl abroad, imports cheaper to Cann residents * i. e. booms/recessions in countries that buy our exports (recession in the U. S. ) appreciation/depreciation resulting from intl speculation in foreign exchange market * Changes in G * Federal spending i. e defense tike &038 municipal spending i. e roads, schools What is the slope of the aggregate-supply curve in the short run? Long run? What shifts AS curve? * AS curve shows the total quantity of g/s firms produce &038 sell at any given P * Upward-sloping in short run * just in long run Natural rate of output (Yn) us the amt of output the economy produces when unemployment is at its natural rate * Yn is also called authorisation output/full-employment output * Yn determined by the economys labour (L) capital (K), and natural resources(N), and on the lvl of tech(A) * Changes in L/Natural rate unemployment immigration, Baby-boomers retire, govt policies reduce natural u-rate * Changes in K/H Investment in factories, more ppl get college degrees, factories destroyed by a hurricane * Changes in natural resources(N) discovery of new mineral deposits, reduction in supply of imported oil, changing weather patterns that affect agricultural production * Changes in tech (A) productivity improvements from technological progress * An increase in P does not affect any of these, it does not affect Yn (Classical dichotomy) * Any even that changes any of the determinants of Yn will shift LRAS * i. e. immigration increases L, causing Yn to rise * Over the LR, tech progress shifts LRAS to the right &038 growth in the MS shifts AD to the right * Ongoing inflation &038 growth in output * The SRAs curves is up sloping * Over the period of 1-2 yrs, an increase in P causes an increase in quantity of g/s supplied * If AS is vertical, fluctuations in AD do ot cause fluctuations in output/employment * If AS slopes up, then shifts in AD do affect output &038 employment * Three theories * Sticky wage theory, Imperfection- nominal honorarium are adhesive in the short run, they adjust sluggishly, due to labour contracts firms &038 workers set the nominal wage in advance based on Pe, the price lvl expected to prevail * If P>Pe, revenue is higher, but labour cost is not. Productions is more profitable, so firms increase output &038 employment * Hence, high P causes higher Y, so the SRAS curve slopes upward * Sticky price theory, Imperfection- many prices are aroused in the short run due to wag costs, the costs of adjusting prices, i. e. ost of printing new menus, the time required to change price tags * Firms set sticky prices in advance based on Pe * Suppose the BoC increases the MS unexpectedly, in LR P will rise * In SR, firms w/o menu costs can raise their P immediately * Firms w/ menu costs wait to raise prices, meantime , their prices are relatively low, which increase demand for their products, so they increase output &038 employment * Hence, higher P is associated w/ higher Y, so the SRAS curve slopes upward * Misperceptions- imperfection firms may confuse changes in P with changes in the relative price of the products they sell, if P rises above Pe- a firm sees its price rise before realizing all prices are rising. The firms may believe its relative price is rising &038 may increase output &038 employment, * An increase in P can cause an increase in Y, making the SRAS curve upward-sloping * What 3 theories have in common Y deviates from Yn, when P deviates from Pe * Y(Output) = Yn + a(P-Pe) * Yn-Natural rate of output (LR) * a>0, measures how much Y responds to unexpected changes in P * P, actually price lvl Pe, expected price lvl * SRAS &038 LRAS The imperfections in these theories are temp, over time * Sticky wage &038 prices become flexible * Misperceptions are corrected * In LR * Pe = P, Y=Yn, AS is vertical * Unemployment is at its natural rate * Why the SRAS curve ability shift * Everything that shifts LRAS shifts SRAS too * Also, Pe shifts SRAS * If Pe rises, workers &038 firms set higher wages * At e/ P production is less profitable, Y falls, SRAS shifts left * * Economic fluctuations * Caused by events that shift the AD/AS curves * 4 steps to analyzing economic fluctuations * Determine whether the event shifts AD &038 AS * Determine whether curve shifts left/right Use AD-AS diagram to see how the shift changes Y &038 P in the short run * Use AD-AS diagram to see how economy moves from new SR eqm to new LR eqm * I. e. phone line market crash C falls, so AD shifts left SR eqm at B, P &038 Y lower, unemp higher Over time Pe fals, SRAS shifts right, until LR eqm at C, Y and unemp back at initial lvls * * i. e. oil prices rises increases costs, shifts SRAS Left, SR eqm at point B, P higher, Y lower, unemp higher from A to B, stagflation a period of falling output &038 rising prices if policymakers do nothing low employment causes wages to fall SRAS shifts right until LR eqm at A, or policymakers could use fiscal/ monetary policy to increase Ad &038 accommodate AS shift Y back to Yn, but P permanently higher