Ecn 204 Final Exam Notes

Macro last(a) Exam Chapter 10 The M maviny Systems What as exercise fares be considered nones? What be the functions of property and the types of notes? * W/o bullion, cover would require barter Exchanging one good/service for an smart(prenominal) * un uniformly occurrence that devil wad e/ live with a good that former(a) wants * 3 functions * median(a) of qualify an item bargain forers give to sellers when they want to purchase g/s * Unit of account the yardstick ppl example to post footings & record debts * submit of rank an item ppl suffer use to transfer purchasing advocate from the present to the future * 2 kinds Commodity notes commodity with essential value, i. e. gold coins * Fiat notes coin w/o native value, used as bullion b/c of govt decree, i. e. vaulting horse bill bills * property in johnn prudence * Money make come forth (Money stock) the standard of cash available in the economy * Two assets should be considers * silver the pap er bills & coins in the hands of the general overt * use up deposits parallelisms in chamfer accounts that despositors clear access on contain by writing a cheque/using debit card * Money Supply = cash + depositsWhat is the edge of passelada and its role? How do commits create money? * primeval Bank an institution designed to regulate the money supplement in the economy * Bank of rearada the primordial bank of Canada * Established in 1935, nationalized in 1938, owned by Cann govt * Managed by board of directors ap blockageed by minister of Finance, composed of g everyplacenor, the senior replacement governor (7 yr equipment casualty), 12 directors (3 yr terms) * Four primary functions * expel cash, act as banker to mercenary banks & Cann govt, come across money go forth * moneymaking(pre token(a)) Banks and Money Supply Although Bank of Canada alone is prudent for Canadian monetary policy, the central bank can control the supplement of money only through its set on the entire banking musical arrangement * Commercial banks include credit unions, caisses populaires, and trust companies * Commercial banks can influence the amount of remove deposits in economy and money supplement * militia cash that commercial banks hold * Fractional banking system Keeps fraction of deposits as deems, rest is loaned * Banks may hold more than than(pre nominative) than this minimum amt if they contain * The reserve ratio, R Fraction of deposits that banks hold as reserves * Total reserves as % of total deposits * Bank T-account * T-account simplified accounting statement that shows banks Assets & liabilities * Banks liabilities deposits(what we put in the bank), Assets Loans and reserves(What bank keeps) * R= Reserves/Deposits * Banks & money supply * $ ascorbic acid of currency is in circulation, determining impact on money supply Calculate in 3 different cases * No banking system Public holds the $ degree Celsius as currency Money supply = $100 * 100% reserves banking system banks hold 100% of deposits as reserves make no loans * MS = Currency (loans) + deposits = 0 +100 = 100 * Bank does not guess 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 advanced debt/loan (liability) * Money Multiplier The amt of money the banking system gene directs with each dollar 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- commercialise operations * When it sullys govt bonds from/ sells to the public * Foreign metamorphose foodstuff place place operations when it buy/sells outside currencies * MS extend when bank of Canada buys exotic currency with Canadian Currency and decrease when BoC sells unknown currency * 2. Changing the overnight rove * Central banks act as bankers to commercial banks Bank drift worry locate charged by bank of Canada on loans to the commercial banks * Since 1998 Bank of Canada as whollyowed commercial banks to borrow freely at the bank measure, give commercial banks the bank esteem, minus half percent, on their deposits at bank of Canada * Commercial banks never need to profit more than bank graze for unequal term loans, b/c they can incessantly borrow from the Bank of Canada instead * Conversely, commercial banks never need to accept less than the bank sum up, minus half a percent, when they make curt-term loans, because they can always lend to the bank of Canada instead * all overnight rate the sake rate on very compendious-term loans between commercial banks * Bank of Canada can spay the money supply by changing the bank rate, which in turn causes an equal turn in overnight rate * A high bank rate discourages commercial banks from borrowing from the Bank of Canada * A high overnight rate discourages commercial banks from borrowi ng from opposite commercial banks * An profit in the overnight rate crucifys the quantity of reserves in the banking system, which in turn reduces the money supply * Bank of Canadas control of MS is not precise * 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 pomposity How does the money supply affect the flash & titulary cargon place? * amount of money theory of money cost rises when govt prints too a lottimes money * Most economists believe the quantity theory is a good explanation of the longsighted run appearance of fanf be * Asserts that quantity of money determines value * 2 approaches * Supply pray diagram MS driven by bank of Canada, banking system, consuers * In model, slang that BoC precisely controls MS & sets it at some(prenominal) fixed amt * MD (money petition) how a good deal wealth ppl want to hold in liquid form * Depends on P an increase in P reduces the value of money, so more money is required to buy goods & work * Thus Quantity of money leaded is vely related to the value of money +vely related to P, other things equal ( reliable income, fill pass judgment, availability of ATMs) * * Results from Graph Increasing MS causes P to rise * How does this acidify? Short version * AT the initial P, an increase in MS causes b are supply of money * People get rid of their excess money by spending it on goods & services/ by loaning it to others who spent it * Result increased demand of goods But supply of goods does not increase, so wrongs must rise * Other things happen in the short run, which we allow for study in later chapters) * Equation * titular Variables are measured in monetary units * i. e. Nominal gross national help product, titulary stakes rates (rate of birth measured in $) nominal wage($ per/ min worked) * factual Var iables are measured in physical units * i. e. veritable GDP legitimate involution rate (measured in issue) hearty wage (measured in production) * Real vs. Nominal * damages are normally measured in terms of money * Price of a compact disc $15/cd * Price of a pepperoni pizza $10/pizza A relative bell value of one good relative (divided by) another * Relative determine 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 material variables * Real vs. Nominal plight * An important relative price is the real wage * W= nominal wage= price of labour $15/hr * P = price level = price of g&s $5/unit of take signal * Real wage is price of labour relative to price of sidetrack * W/P = 15/5 = 3 units output per hour * Classical theory of splashiness * summation in overall level of prices * Over past 60 yrs, prices risen on avg of 4%/yr Deflation concourse will wait for prices to drop on big ticketed items, dropped in the 20th century * In 1970s prices rose by 7%/yr * During 1990s, price rose at 2%/yr * Hyperinflation peculiar high rate * Quantity theory of money explain long haul determinants of price lvl and inflation rate * Inflation is an economy-wide phenomenon that concerns the value of the economys medium of shift * When the overall price level rises, value of money expunges * Inverse relationship b/w price & 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 duality Classical dichotomy theoretical separation of nominal & real variables * Hume & the absolute economists suggested that monetary developments affect nominal variables but not real variables * If the central bank geminates the MS, Hume & classical thinkers con melt down * All nom variables (inclu ding prices) will double * All real variables (Including relative prices) will remain un modifyd * The disinterest 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 example does not change * The same applies to profession of with child(p) & other resources * Since employment of all resources in unchanged, total output is in any case unchanged by the MS * Most economists believe the classical dichotomy & neutrality of money describe the economy in the long run D oes 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 was used in 3 transactions * 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 & resources * So, P changes by the same % as P*Y and M * Rapid money supply issue causes quick inflation How is inflation like a tax? Hyperinflation is generally outlined as inflation sub referableing 50%/month * Excessive growth in the MS always causes hyperinflation * Inflation tax * When tax receipts is inadequate and ability to borrow is ltd, govt may print money to redeem for its s pending * Almost all hyperinflations start this way * The tax revenue from printing money is the inflation tax printing money causes inflation, which is like a tax on anyone who holds money * The Fischer Effect * Rearrange de phoebe birdition of real interest rate * Nominal interest rate = Inflation rate + real interest rate * Real interest rate is determined by speech & investment in the loanable pecuniary resource trade * 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 wreath * Fishcher final result an increase in inflation causes an equal increase in the nominal interest rate, so the real interest rate is unchanged What are the cost of i nflation? How hard are they? * The inflation fallacy most ppl think inflation erodes real income * Inflation is a general increase in price of the things ppl buy & 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 time & transactions costs of more public bank withdrawals * Menu costs the costs of changing prices Printing new menus, mailing new catalogs * Misallocation of resources from relative-price variability Firms dont all come along prices the same time, so relative prices can vary which distorts the allocation of resources * awe & inconvenience inflation changes the yardstick we use to measure transactions, complicates long-range proviso & the comparison of dollar amts over time * Tax distortions inflation makes nominal income grow faster than real income, taxes are based on nominal income, & some are not adjusted for inflation, so inflation causes ppl to pay more taxes even when their real incomes dont increase * verifying redistributions of wealth Higher-than- evaluate inflation transfers purchasing cause 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 & less predictable than natural depression inflation * So, these arbitrary redistributions are frequent when inflation is high * be are high for economies experiencing hyperinflation * For economies w/ low inflation ( 0, Capital safety valve, national purchases of impertinent assets exceed conflicting purchases of home(prenominal) assets * Capital is sleek out of country * When NCO 0, Capital inflow, contradictory purchases of domestic assets exceed domestic purchases of foreign assets * Capital is flowing into the country * Variables that In fluence NCO * Real interest rates paid on foreign assets or domestic assets * Perceived risks of holding foreign assets * Govt policies affecting foreign self-possession of domestic assets * The equality of NX & 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 noncitizen purchases a good from Canada, * Cann exports & 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 ( & vice versa) * When a Cann citizen buys foreign goods, * Cann imports rise, NX waterfall * The Cann buyer pays w/ Cann dollars or assets, so the other country acquires Cann assets, causing Cann NCO to fall * Saving, Investment, & international Flows of Goods & 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 notes flow abroad in the form of positive net seat of government outflow, NCO 0 * When S e =P*/P implies that the nom transmute rate between 2 countries should equal the ratio of price lvls * If the 2 countries have diff inflation rates, then e will change over time * If inflation is higher(prenominal)(prenominal) 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 * some goods cannot easily be traded * i. e. haircuts, going to movies * Price differences on such goods cannot be arbitraged away * Foreign, domestic goods not pure(a) substitutes * i. e. some Cann consumers prefer Toyatos over Chevys * Price dif ferences 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 blossom out economy w/ arrant(a) Capital mobility * Why do interest rates in Canada & the U. S. tend to move up & down together? * Canada is a small open economy w/ perfect capital mobility * small = small quit of the world economy * Canada is an economy w/ perfect capital mobility b/c * Canns have full access to world fiscal merchandises, * And the rest of the world has full access to the Cann finl market * This means that the real interest rate in Canada should equal the real rate prevailing 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 cognize 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 assume w/ them the possibility 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 Funds S=I + NCO * Supply of loanable funds = saving * A dollar of saving can be used to pay * The purchase of domestic capital * The purchase of foreign asset * So, demand for loanable funds=I + NCO * S depends +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 attractive relative to foreign assets * Canns purchase more foreign assets * Canns purchase fewer domestic assets * NCO rises * The supply & demand for loanable funds depend on the real interest rate * A higher real interest rate encourages ppl to save & raises the quantity of loanable funds supplied * The interest rate adjusts to bring the supply & demand for loanable funds into end * At eqm interest rate, the amt that ppl want to save incisively equilibrates the desired quantities of domestic investment & foreign investment * Loanable funds market diagram * R adjusts to balance supply & demand in the LF market * Both I & NCO depend vely on r, so the D worm is downward- aslope * * 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 nest egg 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 & foreign-currency exchange connected? The market for foreign-currency exchange exists b/c ppl want to trade w/ ppl in other countries, but they want to be paid in their own curren cy * 2 side of foreign-currency exchange market are represented by NCO & NX * NCO represents the imbalance between the purchases & sales of capital assets * NX represents the imbalance b/w exports & imports of goods & services * Another identity from introductory 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 occupants provide/give dollars when they buy foreign assets * S=I + NCO S I =NX * What price balances the supply & 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 lift for dollars (NX) is downward sloping b/c a higher exchange rate makes domestic goods more expensive * The supply convolute (NCO) is vertical b/c the quantity of dollars supplied for NCO is unrelated to the real exchange rate * Increase in E makes Cann goods more expensive to foreigners, reduces foreign demand for Cann goods & dollars, does not affect NCO/supply of dollars * The real E adjusts to balance the S & 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&D 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 = give notice supply of dollars How do govt cipher deficits affect exchange rate & trade balance? * The effects of a budget deficit * National saving falls * The real interest ra te rises * Domestic investment & net capital outflow both 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 & demand comes from domestic investment & NCO * In the market for foreign-currency exchange, suplly comes from NCO & demand comes from BX * * * Eqm in the open economy * Prices in the loanable funds market & the foreign-currency exchange market adjust simultaneously to balance supply & demand in these two markets * As they, they determine the macroeconomic variables of national saving, domestic investment, NCO, and NX How do other policies or events affect the interest rate, exchange rate, and trade balance? The order of magnitude & variation in important macroeconomic variables depend on the pursuance * Increase in world interest rates * Govt budget deficits & surpluses * Trade policies * Political & economic stability * Three steps in using the model to analyze these events * delimitate which of the s/d wriggles e/ event effects * Determine which way the disregards shift * Examine how these shifts alter the economys equilibrium * * * Increase in world interest rates * Events outside 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, * Cause NCO to increase & * Causes the dollar to depreciate * The effects of an increase in the govt budget deficit * * Govt budget deficits & surpluses * b/c a govt budget deficit represents negative public saving, it reduces national saving, and therefore reduces * the supply of loanable funds * NCO * The supply of Cann dollars in the market for foreign-currency exchange * Trade Policy is a govt policy that directly influences the quantity of goods s ervices that a country imports/exports * tariff a tax on imported goods * Imported quota a narrow down on quantity of a good relieve oneselfs abroad and sold domestically * Initial impact 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, & 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 increased demand for dollars in the market for foreign-currency * This leads to an appreciation of the real exchange rate * Effect of an import quota * An appreciation of the dollar in the foreign exchange market discourages exports * This offsets the initial increase in NX due to import quota * Trade policies do not affect the trade balance Political Instability & Capital Flight * Capital flight * Is gigantic & sudden lessening 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 become concerned about the safety of their investments, capital can quickly leave an economy * Interest rates increase & the domestic currency depreciates * When investors around 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 & 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 locomote real incomes & emerging unemployment * De pressions severe recessions (very rare) * SR economic fluctuations are often called business cycles * 3 facts about economic fluctuations * Are irregular & episodic * Most macroc quantities fluctuate together * As output falls, unemployment rises Use mode of AD & AS to study fluctuations * Short run, changes in nominal variables (Ms or P) can affect real variables (Y/U-rate) How does the model entirety demand & supply explain economic fluctuations? * Aggregate-demand curve shows the quantity of goods & services that households, firms, & the govt want to buy each price level * Aggregate-supply curve- shows the quantity of goods & services that firms choose to produce and sell at each price level * Why does the aggregate-demand curve slope downward? What shifts the AD curve? * AD curve shows quantity of g/s demanded in the economy at any given P * Y=C+I+G+NX * Assume G fixed by govt policy Increase in P reduces the quantity of g/s demanded b/c * The wealth effect (c falls) * The d ollars 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 decent 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 provincial & 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 & sell at any given P * Upward-sloping in short run * Vertical 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 potential 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 artless 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 & growth in the MS shifts AD to the right * Ongoing inflation & growth in output * The SRAs curves is upward 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 & employment * Three theories * Sticky wage theory, Imperfection- nominal reinforcement are sticky in the short run, they adjust sluggishly, due to labour contracts firms & workers set the nominal wage in advance based on Pe, the price lvl expected to prevail * If PPe, revenue is higher, but labour cost is not. Productions is more profitable, so firms increase output & employment * Hence, high P causes higher Y, so the SRAS curve slopes upward * Sticky price theory, Imperfection- many prices are sticky in the short run due to menu 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 & employment * Hence, higher P is associated w/ higher Y, so the SRAS curve slopes upward * Misperceptions- disgrace 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 in front realizing all prices are rising. The firms may believe its relative price is rising & may increase output & 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) * a0, measures how much Y responds to unexpected changes in P * P, actually price lvl Pe, expected price lvl * SRAS & LRAS The imperfections in these theories are temp, over time * Sticky recompense & 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 energy shift * Everything that shifts LRAS shifts SRAS too * Also, Pe shifts SRAS * If Pe rises, workers & 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 & AS * Determine whether curve shifts left/right Use AD-AS diagram to see how the shift changes Y & P in the short run * Us e AD-AS diagram to see how economy moves from new SR eqm to new LR eqm * I. e. line of credit market crash C falls, so AD shifts left SR eqm at B, P & 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 locomote output & 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 & accommodate AS shift Y back to Yn, but P permanently higher