Aggregate Demand and Supply Analysis
Uploaded by
lisa xuAggregate Demand and Supply Analysis
Uploaded by
lisa xuCommon questions
Powered by AIIf crowding out is ignored, the MPC can be estimated by calculating the multiplier effect of government spending on total demand. With government spending of $10 billion increasing total demand by $30 billion, the multiplier would be 3, implying an MPC of 0.66, since the multiplier is the reciprocal of (1-MPC).
If the Bank of Canada erroneously believes the natural rate of unemployment is higher than it is, it might adopt a less aggressive monetary policy stance aimed at reducing inflation, potentially leading to higher actual unemployment. This misjudgment can result in an output gap where actual unemployment exceeds the natural rate, increasing the social costs of unemployment . A mismatch in perception can thus prolong economic adjustments and negatively impact growth .
The upward slope of the short-run aggregate-supply curve in sticky-wage theory arises because wages are slow to adjust to changes in economic conditions due to contracts and worker expectations . When prices increase, real wages drop temporarily, encouraging firms to increase hiring and output. Conversely, when prices drop, real wages rise, discouraging hiring and reducing output temporarily until wages adjust .
Under a flexible exchange rate, increased U.S. demand for Canadian exports causes an appreciation of the Canadian dollar, which partially offsets the initial increase in aggregate demand, leading to a smaller outward shift in the aggregate demand curve. In contrast, under a fixed exchange rate, the exchange rate doesn't adjust; therefore, the full effect of increased export demand results in a more significant rightward shift of the aggregate-demand curve without currency appreciation dampening the effect .
Expansionary fiscal policy is more likely to stimulate a short-run increase in investment when the investment accelerator is large because it implies that an increase in aggregate demand significantly boosts investment. The accelerator effect means firms quickly respond to higher demand by increasing investment to expand production capacity . This reaction is amplified when firms expect continued demand growth, as is often the case in situations with a large accelerator .
An investment boom increases capital stock due to heavy investments in new capital equipment, which shifts the long-run aggregate supply curve to the right as the productive capacity of the economy grows . This expansionary effect enhances the economy's potential output, allowing it to sustain a higher level of real output in the long run .
Short-duration wage contracts can mitigate the severity of a recession under contractionary monetary policy because wages can adjust more quickly to changing economic conditions. As contracts are renegotiated more frequently, wages can fall in response to lower demand and economic stagnation, facilitating a faster return to full employment and reducing the potential duration and depth of a recession .
In the short run, a stock market crash reduces aggregate demand, leading to lower output and price levels which can increase unemployment due to the demand shortfall . According to the sticky-wage theory, in the long run, wages adjust downward as contracts are renegotiated, eventually leading to a return to long-run equilibrium output as firms reduce production costs and increase output back to its potential level . The expected price level plays a crucial role as it influences wage and price settings, ensuring the real wage aligns with equilibrium conditions .
In the short run, expansionary monetary policy can counteract the fall in aggregate demand by lowering interest rates, boosting consumption, and investment, thereby increasing aggregate demand to restore full employment and placing the economy back on its original Phillips curve with a lower interest rate . However, in the long run, the economy adjusts back to its natural rate of unemployment, with only higher price levels due to increased money supply .
A 5% increase in money supply initially increases aggregate demand, shifting the demand curve to the right which raises both output and the price level in the short-run (point B). In the long run, however, assuming wages are sticky, the increased demand leads to higher inflation expectations, causing a rise in nominal wages. As wages adjust, the economy returns to its natural rate of unemployment with a higher price level and unchanged real output (point C). This reflects the long-term neutrality of money where only prices adjust .