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Equilibrium GDP and Prices

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msk2222's version from 2018-01-22 00:07

Section 1

Question Answer
AD and AS model, we can combine them to determine the real level of GDP and the price levelEquilibrium occurs where the AD and AS curves intersect
Equilibriumquantity of aggregate output demanded (or the level of aggregate expenditures) is equal to the quantity of aggregate output supplied.
four possible types of macroeconomic equilibrium1. Long-run full employment Short-run recessionary gap Short-run inflationary gap Short-run stagflation
Long-Run Equilibriumequilibrium occurs where the AD curve intersects the SRAS curve at a point on the LRAS curve. Because equilibrium occurs at a point on the LRAS curve, the economy is at potential real GDP. Both labor and capital are fully employed, and everyone who wants a job has one. In the long run, equilibrium GDP is equal to potential GDP.
Recessionary GapCyclical fluctuations in real GDP and prices are caused by shifts in both the AD and SRAS curves. A decline in AD or a leftward shift in the AD curve results in lower GDP and lower prices. Such declines in AD lead to economic contractions, and if such declines drive demand below the economy’s potential GDP, the economy goes into a recession. Most importantly, in contrast to full employment, equilibrium GDP is below potential GDP.
Investment Implications of a Decrease in ADcaused by a decline in AD, the following conditions are likely to occur: Corporate profits will decline. Commodity prices will decline. Interest rates will decline. Demand for credit will decline.
following investment strategy: Recessionary GapReduce investments in cyclical companies16 because their earnings are likely to decline the most in an economic slowdown. Reduce investments in commodities and/or commodity-oriented companies because the decline in commodity prices will slow revenue growth and reduce profit margins. Increase investments in defensive companies17 because they are likely to experience only modest earnings declines in an economic slowdown. Increase investments in investment-grade or government-issued fixed-income securities. The prices of these securities should increase as interest rates decline. Increase investments in long-maturity fixed-income securities because their prices will be more responsive to the decline in interest rates than the prices of shorter-maturity securities. Reduce investments in speculative equity securities and in fixed-income securities with low credit quality ratings.
Inflationary GapThe unemployment rate declines. Once an economy reaches its potential GDP, however, companies must pay higher wages and other input prices to further increase production. The economy now faces an inflationary gap, measured by the difference between Y2 andY1 in Exhibit 24. An inflationary gap occurs when the economy’s short-run level of equilibrium GDP is above potential GDP, resulting in upward pressure on prices.
Investment Implications of an Increase in AD Resulting in an Inflationary GapCorporate profits will rise. Commodity prices will increase. Interest rates will rise. Inflationary pressures will build.
investment strategy;Inflationary GapIncrease investment in cyclical companies because they are expected to have the largest increase in earnings. Reduce investments in defensive companies because they are expected to have only a modest increase in earnings. Increase investments in commodities and commodity-oriented equities because they will benefit from higher production and output. Reduce investments in fixed-income securities, especially longer-maturity securities, because they will decline in price as interest rates rise. Raise exposure to speculative fixed-income securities (junk bonds) because default risks decrease in an economic expansion.
memorize

Section 2

Question Answer
stagflationStructural fluctuations in real GDP are caused by fluctuations in SRAS. Declines in aggregate supply bring about stagflation—high unemployment and increased inflation. Increases in aggregate supply conversely give rise to high economic growth and low inflation.
Investment Implications of Shift in ASFrom an investment perspective, a decline in AS (leftward shift of the SRAS curve) suggests reducing investment in fixed income because rising output prices (i.e., inflation) put upward pressure on nominal interest rates; reducing investment in most equity securities because profit margins are squeezed and output declines; and increasing investment in commodities or commodity-based companies because prices and profits are likely to rise.
Conclusions on AD and ASAn increase in AD raises real GDP, lowers the unemployment rate, and increases the aggregate level of prices. A decrease in AD lowers real GDP, increases the unemployment rate, and decreases the aggregate level of prices. An increase in AS raises real GDP, lowers the unemployment rate, and lowers the aggregate level of prices. A decrease in AS lowers real GDP, raises the unemployment rate, and raises the aggregate level of prices.
both curves shift,Both AD and AS increase. If both AD and AS increase, real GDP will increase but the impact on inflation is not clear unless we know the magnitude of the changes because an increase in AD will increase the price level, whereas an increase in AS will decrease the price level. If AD increases more than AS, the price level will increase. If AS increases more than AD, however, the price level will decline. Both AD and AS decrease. If both AD and AS decrease, real GDP and employment will decline, but the impact on the price level is not clear unless we know the magnitude of the changes because a decrease in AD decreases the price level, whereas a decrease in AS increases the price level. If AD decreases more than AS, the price level will fall. If AS decreases more than AD, the price level will rise. AD increases and AS decreases. If AD increases and AS declines, the price level will rise, but the effect on real GDP is not clear unless we know the magnitude of the changes because an increase in AD increases real GDP, whereas a decrease in AS decreases real GDP. If AD increases more than AS declines, GDP will rise. If AS decreases more than AD increases, real GDP will fall. AD decreases and AS increases. If AD decreases and AS increases, the price level will decline but the impact on real GDP is not clear unless we know the magnitudes of the changes because a decrease in AD decreases real GDP, whereas an increase in AS increases real GDP. If AD decreases more than AS increases, real GDP will fall. If AS increases more than AD declines, real GDP will rise.
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Section 3