Classical AS/AD

• What are the two major schools of thought on aggregate demand and aggregate supply?

  Classical and Keynesian
• What primarily causes the differing views between the classical and Keynesian schools?

  Different interpretations of aggregate supply
• According to the classical model, what are the two types of aggregate supply curves?

  Short-run and long-run
• In the classical model, what determines the position of the short-run aggregate supply curve?

  Costs of production
• According to the classical model, what causes the short-run aggregate supply (SRAS) curve to shift to the left?

  An increase in costs of production
• What is the slope of the short-run aggregate supply (SRAS) curve in the classical model?

  Upward sloping
• In the classical model, what determines the position of the long-run aggregate supply curve?

  Quantity and quality of factors of production
• What does the vertical long-run aggregate supply curve represent in the classical model?

  Full employment level of output
• In the classical model, what could cause the long-run aggregate supply curve to shift to the right?

  An increase in factors of production
• What are the two equilibrium conditions in the classical model?

  AD = SRAS and AD = LRAS
• Which component of the aggregate supply model do both the classical and Keynesian schools agree on?

  Aggregate demand
• How do classical economists define the short run?

  Wages are fixed
• How do classical economists define the long run?

  Wages are variable
• According to the classical model, does the model contain specific time frames for the short run and long run?

  No, there are no specific time frames
• What do classical economists believe will happen in the long run without government intervention?

  The economy will return to full employment
• In the classical model, if aggregate demand decreases, what is the initial impact on firms?

  Firms must make decisions about production levels
• In the classical model, if firms want to maintain full employment output after a decrease in aggregate demand, what is the most effective way to do this?

  Reduce their costs
• According to the classical model, why might firms be hesitant to reduce their workforce during a recession?

  Workers may have valuable skills
• According to the classical model, what is a major cost that firms have control over?

  Wages
• According to the classical model, why are wages typically fixed in the short run?

  Minimum wages, unemployment benefits, and trade unions
• What are the three reasons wages tend to be fixed in the short run?

  Minimum wages, unemployment benefits, and strong trade unions
• What is the result of lower output and higher unemployment in the classical model?

  Deflationary gap
• In the classical model, what causes workers to revise down their wage expectations in the long run?

  Persistent unemployment
• In the classical model, what is the long-run effect of workers accepting lower wages?

  SRAS shifts right, restoring full employment
• In the classical model, what happens to inflation during the adjustment from recession to full employment?

  Inflation decreases
• In the classical model, what is the effect of an increase in aggregate demand beyond full employment?

  Short-run increase in output and prices
• Why can firms temporarily produce beyond the full employment level of output?

  Existing workers work overtime
• According to the classical model, why are workers slow to demand higher wages during a boom?

  They are slow to realize their increased bargaining power
• In the classical model, what happens when workers demand higher wages during a boom?

  SRAS shifts left, restoring full employment
• What is an inflationary gap?

  Output is above full employment level
• What are the characteristics of an inflationary gap?

  Higher output and lower unemployment
• According to the classical model, what is the primary long-run effect of demand-side policies?

  Increase in inflation
• Why are classical economists known as supply-side economists?

  They emphasize supply-side policies to increase output
• According to classical economists, what type of policies are needed for sustainable growth?

  Supply-side policies
• What are the components of aggregate demand?

  G + X - M
• What is deflation?

  Inflation rate going negative
• What does the natural rate of unemployment account for?

  Frictional and structural unemployment