Solow, Ad, and Sras Growth Curves Dealing with Monetary and Fiscal Policy

Topics: Macroeconomics, Inflation, Economics Pages: 8 (2193 words) Published: April 18, 2013
1. What is the Solow (or long-run) growth curve, why is it vertical, and what causes it to shift? Solow growth curve is a production function that expresses the relationship between output and the factors of production. the formula is Y = F(A,K,eL) where A= ideas, K = physical captial, L = Labor, and e = natural resources. The Solow growth curve is represented by a vertical line at the Solow growth rate because: I. it does not depend on the rate of inflation.

II. there is an underlying assumption of strong money neutrality. Negative shockto left(drought)
Positive shockto right(price drops)

2. What is the aggregate demand (AD) curve, why does it slope downward, and what causes it to shift? shows all the combinations of inflation and real growth that are consistent with a specified rate of spending growth -wealth effect, interest rate effect, net export effect

A decrease in c (inward SR)
Increase in MS (right)
Collapse in housing mkt (left)

3. What is a long-run equilibrium and what does it imply about the economy?

Long Run Equilibrium
The long run equilibrium occurs where aggregate supply equals aggregate demand. The primary difference in short run and long run analysis is that in the short run, capital is fixed and firms cannot enter or exit the market. Change in production can only occur by changing the amount of labor employed. In the long run, both capital and labor are variable, and firms are free to exit and enter. The long run is associated with the long-run average cost (LRAC) curve in microeconomic models along which a firm would minimize its average cost (cost per unit) for each respective long-run quantity of output. In the short run, a profit-maximizing firm will increase production if marginal cost is less than marginal revenue and decrease production if marginal cost is greater than marginal revenue. 4. What are the implications of demand and real shocks in the two-curve model (with only the Solow growth curve and the AD curve)? Supply curve shift the solow long run growth rate

Demand curve shift the AD curve
5. What were the influence of Adam Smith and John Maynard Keynes on our understanding about how the economy works? Adam Smith- Classical view “Father of Economics” (invisible hand) Keynes- general theory, sticky wages and prices.

New Keynesian models: models that focus on aggregate demand shocks New Keynesian models: models of the economy with "sticky" (not perfectly flexible) New Keynesian theory: Sticky wages and sticky prices are emphasized in... 6. What are "sticky" wages and prices, and what do they imply about the economy? When wages/prices do not respond very quickly to changes in economic conditions

7. What is the short-run aggregate supply (SRAS) curve, why is it upward sloping, and what causes it to shift? The short-run aggregate supply curve is upward sloping because…productivity shocks Short-run aggregate supply (SRAS) curve shows the positive relationship between inflation and real growth during the period when prices are sticky 8. What is a short-run equilibrium?

The time before the economy reaches its long run growth rate 9. What are the implications of demand and real shocks in the complete model (with all three curves)? 10. What process moves the economy to a long-run equilibrium over time (that is, what is the economy's "self-correction" mechanism)? The process restoring the long run equilibrium is called the"self correcting mechanism." The self correcting mechanism will occur whenever the economy is not at full employment. If employment is larger than full employment, as in the above example, wages and resource prices will rise to restore full employment. When the level of employment is less than full employment, wages and resource prices will fall to restore full employment. 11. Why are changes in velocity growth likely to be temporary? Bc the spending components (Consumer spending, investment spending, govt spending, nx...
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