THE ECONOMICS OF MONEY,BANKING, AND FINANCIAL MARKETS 668

636

PA R T V I I Monetary Theory

S U M M A RY
1. 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 ).
2. 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.
3. 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.
1. 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?

7. 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?

3. 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?

9. 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?

5. 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.