How can fiscal policy address an inflationary gap?
Contractionary fiscal policy (e.g., increased taxes, decreased government spending) can reduce aggregate demand.
How can monetary policy address a recessionary gap?
Expansionary monetary policy (e.g., lower interest rates) can increase aggregate demand.
What is the impact of government spending on aggregate demand?
An increase in government spending shifts the AD curve to the right.
What is the impact of increasing taxes on aggregate demand?
An increase in taxes shifts the AD curve to the left.
How does expansionary monetary policy affect interest rates?
It lowers interest rates.
How does contractionary monetary policy affect interest rates?
It raises interest rates.
Evaluate the effectiveness of using fiscal policy to correct a recessionary gap.
Fiscal policy can increase AD, but it may have time lags and potential crowding-out effects.
Evaluate the effectiveness of using monetary policy to correct an inflationary gap.
Monetary policy can decrease AD, but its impact can be uncertain and depend on interest rate sensitivity.
What is the effect of increased government spending on the price level during full employment?
It can lead to inflation if the economy is already at full employment, as it increases aggregate demand without a corresponding increase in aggregate supply.
How does a decrease in the money supply affect investment?
It typically leads to higher interest rates, which can decrease investment spending.
In a recessionary gap graph, where is the equilibrium relative to LRAS?
The equilibrium is to the left of the LRAS curve.
In an inflationary gap graph, where is the equilibrium relative to LRAS?
The equilibrium is to the right of the LRAS curve.
What does a rightward shift of the SRAS curve indicate?
An increase in aggregate supply, possibly due to lower production costs.
What does a leftward shift of the SRAS curve indicate?
A decrease in aggregate supply, possibly due to higher production costs.
What does the intersection of SRAS, LRAS, and AD represent?
Long-run equilibrium at full employment.
How does an increase in consumer confidence show on an AD/AS graph?
It is represented by a rightward shift of the AD curve.
How is long-run adjustment shown on an AD/AS graph after a demand shock?
A shift in the SRAS curve to restore equilibrium at the LRAS curve.
What happens to the price level and output when SRAS shifts left?
Price level increases, and output decreases.
What happens to the price level and output when SRAS shifts right?
Price level decreases, and output increases.
What is the shape of the LRAS curve and what does it represent?
It is vertical, representing the economy's potential output at full employment, independent of the price level.
Define long-run equilibrium.
The point where LRAS, SRAS, and AD intersect, representing full employment output.
What is a recessionary gap?
When equilibrium output is less than full-employment output.
Define inflationary gap.
When equilibrium output is greater than full-employment output.
What is LRAS?
Long-Run Aggregate Supply; represents potential output at full employment.
Define SRAS.
Short-Run Aggregate Supply; shows the relationship between price level and quantity of output supplied in the short run.
What is Aggregate Demand (AD)?
The total demand for goods and services in an economy at a given price level.
Define full employment level of output.
The level of output an economy can produce when it is using all its resources efficiently.
What are economic shocks?
Unexpected events that shift the AD or AS curves.
Define self-correction mechanism.
The economy's natural tendency to return to long-run equilibrium through price and wage adjustments.
What is the natural rate of unemployment?
The unemployment rate that exists when the economy is producing at its potential output.
