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    whether the economy is in a recession is illustrated in the ad/as model by how close the _____________________ is to the potential gdp line.

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    24.4 Shifts in Aggregate Demand – Principles of Economics

    24.4 SHIFTS IN AGGREGATE DEMAND

    Learning Objectives

    By the end of this section, you will be able to:

    Explain how imports influence aggregate demand

    Identify ways in which business confidence and consumer confidence can affect aggregate demand

    Explain how government policy can change aggregate demand

    Evaluate why economists disagree on the topic of tax cuts

    As mentioned previously, the components of aggregate demand are consumption spending (C), investment spending (I), government spending (G), and spending on exports (X) minus imports (M). (Read the following Clear It Up feature for explanation of why imports are subtracted from exports and what this means for aggregate demand.) A shift of the AD curve to the right means that at least one of these components increased so that a greater amount of total spending would occur at every price level. A shift of the AD curve to the left means that at least one of these components decreased so that a lesser amount of total spending would occur at every price level. The Keynesian Perspective will discuss the components of aggregate demand and the factors that affect them. Here, the discussion will sketch two broad categories that could cause AD curves to shift: changes in the behavior of consumers or firms and changes in government tax or spending policy.

    Do imports diminish aggregate demand?

    We have seen that the formula for aggregate demand is AD = C + I + G + X – M, where M is the total value of imported goods. Why is there a minus sign in front of imports? Does this mean that more imports will result in a lower level of aggregate demand?

    When an American buys a foreign product, for example, it gets counted along with all the other consumption. So the income generated does not go to American producers, but rather to producers in another country; it would be wrong to count this as part of domestic demand. Therefore, imports added in consumption are subtracted back out in the M term of the equation.

    Because of the way in which the demand equation is written, it is easy to make the mistake of thinking that imports are bad for the economy. Just keep in mind that every negative number in the M term has a corresponding positive number in the C or I or G term, and they always cancel out.

    HOW CHANGES BY CONSUMERS AND FIRMS CAN AFFECT AD

    When consumers feel more confident about the future of the economy, they tend to consume more. If business confidence is high, then firms tend to spend more on investment, believing that the future payoff from that investment will be substantial. Conversely, if consumer or business confidence drops, then consumption and investment spending decline.

    The University of Michigan publishes a survey of consumer confidence and constructs an index of consumer confidence each month. The survey results are then reported at http://www.sca.isr.umich.edu, which break down the change in consumer confidence among different income levels. According to that index, consumer confidence averaged around 90 prior to the Great Recession, and then it fell to below 60 in late 2008, which was the lowest it had been since 1980. Since then, confidence has climbed from a 2011 low of 55.8 back to a level in the low 80s, which is considered close to being considered a healthy state.

    One measure of business confidence is published by the OECD: the “business tendency surveys”. Business opinion survey data are collected for 21 countries on future selling prices and employment, among other elements of the business climate. After sharply declining during the Great Recession, the measure has risen above zero again and is back to long-term averages (the indicator dips below zero when business outlook is weaker than usual). Of course, either of these survey measures is not very precise. They can however, suggest when confidence is rising or falling, as well as when it is relatively high or low compared to the past.

    Because a rise in confidence is associated with higher consumption and investment demand, it will lead to an outward shift in the AD curve, and a move of the equilibrium, from E0 to E1, to a higher quantity of output and a higher price level, as shown in Figure 1 (a).

    Consumer and business confidence often reflect macroeconomic realities; for example, confidence is usually high when the economy is growing briskly and low during a recession. However, economic confidence can sometimes rise or fall for reasons that do not have a close connection to the immediate economy, like a risk of war, election results, foreign policy events, or a pessimistic prediction about the future by a prominent public figure. U.S. presidents, for example, must be careful in their public pronouncements about the economy. If they offer economic pessimism, they risk provoking a decline in confidence that reduces consumption and investment and shifts AD to the left, and in a self-fulfilling prophecy, contributes to causing the recession that the president warned against in the first place. A shift of AD to the left, and the corresponding movement of the equilibrium, from E0 to E1, to a lower quantity of output and a lower price level, is shown in Figure 1 (b).

    Figure 1. Shifts in Aggregate Demand. (a) An increase in consumer confidence or business confidence can shift AD to the right, from AD0 to AD1. When AD shifts to the right, the new equilibrium (E1) will have a higher quantity of output and also a higher price level compared with the original equilibrium (E0). In this example, the new equilibrium (E1) is also closer to potential GDP. An increase in government spending or a cut in taxes that leads to a rise in consumer spending can also shift AD to the right. (b) A decrease in consumer confidence or business confidence can shift AD to the left, from AD0 to AD1. When AD shifts to the left, the new equilibrium (E1) will have a lower quantity of output and also a lower price level compared with the original equilibrium (E0). In this example, the new equilibrium (E1) is also farther below potential GDP. A decrease in government spending or higher taxes that leads to a fall in consumer spending can also shift AD to the left.

    Source : opentextbc.ca

    Whether the economy is in a recession is illustrated in the AD/AS model by how close the __________ is to the potential GDP line. A) recessionary gap B) AD curve C) AS curve D) current equilibrium GDP

    Answer to: Whether the economy is in a recession is illustrated in the AD/AS model by how close the __________ is to the potential GDP line. A) recessionary...

    AD–AS model

    Whether the economy is in a recession is illustrated in the AD/AS model by how close the...

    Whether the economy is in a recession is illustrated in the AD/AS model by how close the... Question:

    Whether the economy is in a recession is illustrated in the AD/AS model by how close the _____ is to the potential GDP line.

    A) recessionary gap B) AD curve C) AS curve

    D) current equilibrium GDP

    Potential GDP:

    Potential GDP is the level of GDP that would be realized if the economy was using all resources fully such as labor. This means unemployment is at its natural rate when the economy is operating at its potential.

    Answer and Explanation:

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    Answer: D

    The potential GDP line is where we want to be operating in terms of GDP. The current equilibrium GDP is where we are operating today. The...

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    Aggregate Supply and Aggregate Demand (AS-AD) Model

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    The aggregate supply and aggregate demand model allows economists to look at the behavior of the entire economy. Learn how this model differs from supply and demand models in terms of focus, as well as what it looks like in graph form.

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    If the price level of what firms produce is rising across an economy, but the costs of production are constant, then:

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    higher profits will induce expanded production.

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    Melanie decided to save 20% of her annual earnings for 10 years so she would have a down payment for a house. After 5 years, what change in the economy would cause an increase in the purchasing power of the funds she has managed to save?

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    deflation

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    Terms in this set (34)

    If the price level of what firms produce is rising across an economy, but the costs of production are constant, then:

    higher profits will induce expanded production.

    Melanie decided to save 20% of her annual earnings for 10 years so she would have a down payment for a house. After 5 years, what change in the economy would cause an increase in the purchasing power of the funds she has managed to save?

    deflation

    When the economy of a country is operating close to its full capacity:

    cyclical unemployment is close to zero.

    Changes in the price level of the different components of aggregate demand are reflected in the AD/ASAD/AS macroeconomic model by a ________________________.

    downward sloping AD curve

    As the aggregate price level in an economy rises, ____________________.

    interest rates increase

    What is the equilibrium output?

    Occurs when the aggregate demand and supply are equal at the same price level

    Aggregate supply curves are ________________________ for low levels of output, and ____________________________ for high levels of output.

    relatively flat; relatively steep

    In an AD/ASAD/AS diagram, __________________________ could explain a rise in cyclical unemployment?

    a shift to the left in either AS or AD

    When an economy's output increases and the price level decreases, the _________ curve has shifted to the ____________.

    AS; right

    The graph refers to a significant increase in individual income taxes, taking them to their highest level in 50 years. Which of the following is likely to result?

    the economy will experience lower economic growth

    Potential GDP in the U.S. will be unaffected by ____________________.

    the unemployment rate

    Which of the following will have the greatest influence on the slope of the demand curve in a single market model?

    substitute goods

    Whether the economy is in a recession is illustrated in the AD/AS model by how close the _____________________ is to the potential GDP line.

    equilibrium

    The graph reflects a significant increase in world oil prices. What will the impact on aggregate supply most likely lead to?

    an increase in input prices

    Say's Law argues that a given ____________________ must create an equivalent ________________________ somewhere else in the economy.

    value of supply; value of demand

    _______________________ happens when the economy is producing at its potential and unemployment is at the natural rate of unemployment.

    Full employment GDP

    Referring to the diagram, which of the following is a true statement?

    -Macroeconomic policy will be needed to address rising inflation.

    -There is sufficient aggregate demand to cause inflationary pressures.

    -The equilibrium in the economy is at a level of output above full employment.

    -There is insufficient aggregate demand to reach full employment.

    There is insufficient aggregate demand to reach full employment.

    Refer to the graph. A government creating economic policy in these circumstances should be most concerned about:

    unemployment but not inflation.

    Which of the following must be present in order for the aggregate supply curve to form an upward slope?

    fixed cost of inputs combined with rising prices for outputs

    If Keynes' law applies during economic contractions and Say's law applies during economic expansion, how will the three goals of macroeconomics be affected?

    trade-offs and connections may differ in the short run and the long run

    The __________________ in an AD/AS diagram is most relevant to Keynes's Law.

    flat portion of the AS curve

    Changes in the price level of the different components of aggregate demand are reflected in the AD/ASAD/AS macroeconomic model by a ________________________.

    downward sloping AD curve

    Economic production has fallen to less than full potential due to inadequate incentives for firms to produce. The duration of this economic condition will likely be:

    short-term

    In an AD/AS model, the point where the economy has excess capacity is called the:

    Keynesian zone of the AS curve

    _________________ results when an economy experiences high unemployment and high inflation at the same time.

    Stagflation

    Why is productivity growth considered to be the most important factor in the AD/ASAD/AS model?

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