THE ECONOMICS OF MONEY,BANKING, AND FINANCIAL MARKETS 668

636 PA R T V I I Monetary Theory S U M M A RY The aggregate demand curve indicates the quantity of aggregate output demanded at each price level, and it is downward-sloping The primary source of shifts in the aggregate demand curve are changes in the money supply, fiscal policy (government spending and taxes), net exports, and the willingness of consumers and businesses to spend ( animal spirits ) The long-run aggregate supply curve is vertical at the natural rate level of output The short-run aggregate supply curve slopes upward, because a rise in the price level raises the profit earned on each unit of production, and the quantity of output supplied rises Four factors can cause the aggregate supply curve to shift: tightness of the labour market as represented by unem- ployment relative to the natural rate, expectations of inflation, workers attempts to push up their real wages, and supply shocks unrelated to wages that affect production costs Equilibrium in the short run occurs at the point where the aggregate demand curve intersects the short-run aggregate supply curve Although this is where the economy heads temporarily, it has a self-correcting mechanism, which leads it to settle permanently at the long-run equilibrium where aggregate output is at its natural rate level Shifts in either the aggregate demand or the short-run aggregate supply curve can produce changes in aggregate output and the price level KEY TERMS aggregate demand, p 619 Keynesian, aggregate supply, p 619 p 630 aggregate supply curve, p 622 long-run aggregate supply curve, p 629 aggregate supply shock, p 626 monetarist, p 630 consumer expenditure, p 619 natural rate of output, p 624 demand shocks, natural rate of unemployment, p 622 p 622 government spending, p 620 hysteresis, p 632 net exports, p 620 nonaccelerating inflation rate of unemployment (NAIRU), p 623 planned investment spending, p 619 real business cycle theory, p 632 self-correcting mechanism, supply shock, p 630 p 626 QUESTIONS You will find the answers to the questions marked with an asterisk in the Textbook Resources section of your MyEconLab If exports fall while imports rise, what happens to the aggregate demand curve? *6 Profit-maximizing behaviour on the part of firms explains why the short-run aggregate supply curve is upward-sloping Is this statement true, false, or uncertain? Explain your answer *2 If government expenditure goes down while taxes are raised to balance the budget, what happens to the aggregate demand curve? If huge budget deficits cause the public to think that there will be higher inflation in the future, what is likely to happen to the short-run aggregate supply curve when budget deficits rise? Suppose that government spending is raised at the same time that the money supply is lowered What will happen to the position of the aggregate demand curve? *8 If a pill were invented that made workers twice as productive but their wages did not change, what would happen to the position of the short-run aggregate supply curve? *4 Why does the aggregate demand curve shift when animal spirits change? When aggregate output is below the natural rate level, what will happen to the price level over time if the aggregate demand curve remains unchanged? Why? If the dollar increases in value relative to foreign currencies so that foreign goods become cheaper in Canada, what will happen to the position of the short-run aggregate supply curve? The aggregate demand curve? *10 Show how aggregate supply and demand analysis can explain why both aggregate output and the price level fell sharply when investment spending collapsed during the Great Depression