Chapter 13- Aggregate Demand, Aggregate Supply, and Business Cycles

·      Long run equilibrium- a situation in which the AD and AS curves intersect at potential output Y*

·      Short run equilibrium- a situation where the AD and AS curves intersect at a level of real GDP that is above or below potential

·      Aggregate demand (AD) curve- a curve that shows the amount of output consumers, firms, government, and customers abroad want to purchase at each inflation rate, holding all other factors constant

·      Monetary policy rule- a rule that describes how a central bank, like the Fed, takes action in response to changes in the state of the economy

·      Change in aggregate demand- a shift of the AD curve

·      Demand shocks- changes in planned spending that are not caused by changes in output (GDP) or the inflation rate; for example, changes in consumer confidence and consumers’ real wealth can affect consumption even if there has been little change in output or inflation

·      Increase aggregate demand- increase government spending, cut taxes, and decrease the real interest rate

·      Decrease aggregate demand- decrease government spending, raise taxes, and increase the real interest rate

·      Aggregate supply (AS) curve- a curve that shows the relationship between the amount of output firms want to produce and the inflation rate, holding all other factors constant

·      Change in aggregate supply- a shift of the AS curve

·      Inflation shock- a sudden change in the normal behavior of inflation, unrelated to the nation’s output gap; adverse inflation shock increases inflation while a favorable inflation shock decreases inflation

·      Self-correcting property- the fact that output gaps will not last indefinitely, but will be closed by rising or falling inflation