Aggregate Models Flashcards
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In the AD-AS model, stagflation is graphically represented by:
Answer: A leftward shift of SRAS causing both higher prices and lower output
Stagflation — rising inflation combined with falling output — results from a leftward SRAS shift, which pushes prices up while reducing real GDP simultaneously.
The interest rate effect, as an explanation for the downward slope of aggregate demand, works through which mechanism?
Answer: Higher prices reduce real money balances, raising interest rates and reducing investment
When the price level rises, households need more money for transactions, increasing money demand, which raises interest rates and depresses investment and consumption.
In a model with taxes and imports, the value of the expenditure multiplier compared to the simple 1/(1-MPC) multiplier is:
Answer: Smaller, because taxes and imports represent leakages that reduce the multiplier effect
Taxes and imports are leakages that drain spending from each round of the multiplier process, making the real-world multiplier smaller than the simple Keynesian model predicts.
According to the aggregate expenditure model, the 'paradox of thrift' describes a situation where:
Answer: An increase in desired saving by all households leads to a fall in equilibrium income and total saving
When all households try to save more simultaneously, the resulting drop in consumption reduces income, which can leave total saving unchanged or lower — the fallacy of composition in macroeconomics.
If an economy is in long-run equilibrium and the central bank unexpectedly increases the money supply, the SHORT-RUN effect on the AD-AS diagram is:
Answer: AD shifts right, increasing both real GDP and the price level in the short run
Expansionary monetary policy lowers interest rates, boosting investment and consumption, which shifts AD rightward and raises both output and prices in the short run.
In the long-run adjustment after an expansionary demand shock, the self-correcting mechanism restores equilibrium by:
Answer: SRAS shifting leftward as rising wages and input prices increase production costs
In the long run, an inflationary gap drives up wages and resource prices, which raises costs and shifts SRAS leftward until output returns to potential and only the price level is permanently higher.
Which statement about the aggregate expenditure (AE) model and the AD-AS model is CORRECT?
Answer: The AE model holds the price level constant and determines equilibrium output; AD-AS allows the price level to vary
The Keynesian cross (AE model) fixes the price level and finds equilibrium output; the AD-AS model generalizes this by allowing the price level to adjust simultaneously.