Transcript EDITragan_13ce_ch23

1 of 24
Chapter 23
Output and Prices in
the Short Run
Copyright © 2011 Pearson Canada Inc.
2 of 24
In this chapter you will learn...
1. …why an exogenous change in the price level shifts the
AE curve and changes the equilibrium level of real GDP.
2. …how to derive the aggregate demand (AD) curve and
what causes it to shift.
3. …the meaning of the aggregate supply (AS) curve and why
it shifts when technology or factor prices change.
Copyright © 2011 Pearson Canada Inc.
3 of 24
In this chapter you will learn...
4. …how to define macroeconomic equilibrium.
5. …how aggregate demand and aggregate supply shocks
affect equilibrium real GDP and the price level.
Copyright © 2011 Pearson Canada Inc.
4 of 24
23.1 The Demand Side of the
Economy
Exogenous Changes in the Price Level
An increase in P reduces the real value of money holdings.
A fall in P raises the real value of money holdings.
For the private sector - Money and Government Bonds
Changes in P also affect the wealth of private bond holders
and private bond issuers
- but there is no change in aggregate private wealth
Copyright © 2011 Pearson Canada Inc.
5 of 24
An increase in P thus reduces private-sector wealth:
- reduction in desired consumption
- downward shift in AE curve
There is also an effect on net exports:
- the NX function shifts downward and gets flatter
- further downward shift in AE curve
Conversely for a fall in P.
Copyright © 2011 Pearson Canada Inc.
6 of 24
Changes in Equilibrium GDP
AE
AE =Y
E0
•
AE0
AE1
- AE shifts down
•E
- equilibrium Y falls
1
Y1
An increase in P reduces
desired aggregate
expenditure:
Y0
Y
Copyright © 2011 Pearson Canada Inc.
7 of 24
The Aggregate Demand Curve
The aggregate demand (AD) curve relates equilibrium real
GDP to the price level.
For any given P, the AD curve shows the level of real GDP for
which desired aggregate expenditure equals actual GDP.
Changes in the price level cause movements along the AD
curve.
Copyright © 2011 Pearson Canada Inc.
8 of 24
AE
E0
•
AE =Y
AE0 ( at P0)
AE1 (at P1 > P0)
E1
•
AE2 (at P2 > P1)
Consider a rise in the price
level, from P0 to P2:
E2
•
Y2
Y1
Y0
Y
P
P2
The AE curve shifts
down, but we move along
the AD curve.
•
•
P1
P0
• AD
Y2
Y1
Y0
Y
Copyright © 2011 Pearson Canada Inc.
9 of 24
AE
E1
•
AE =Y
AE1
Shifts in the AD Curve
AE0
E0
•
Y0
Y1
Y
Any shock that increases
equilibrium GDP at a
given price level shifts
the AD curve to the right.
P
P0
E0
•
E1
•
AD1
AD0
Y0
Y1
The horizontal shift of the
AD curve is the simple
multiplier times the
change in autonomous
spending.
Y
Copyright © 2011 Pearson Canada Inc.
10 of 24
23.2 The Supply Side of the Economy
The Aggregate Supply Curve
The AS curve relates the price level to the quantity of output
that firms would like to produce and sell.
The AS curve is drawn for a given:
- level of technology
- set of factor prices
As unit costs rise with output, firms will produce more output
only if prices increase:
 AS curve is upward sloping
Copyright © 2011 Pearson Canada Inc.
11 of 24
Price Level
Shifts in the Aggregate Supply Curve
Anything that increases
firms’ costs causes the
AS curve to shift up:
AS1
•
P1
AS0
- factor prices
- technology
P0
•
Y1
•
Y0
- regulation
Real GDP
Why does AS get
steeper as output
rises?
Copyright © 2011 Pearson Canada Inc.
12 of 24
What does the Aggregate Supply Curve look like?
Until this point we have assumed that the aggregate supply
(AS) was perfectly elastic (a horizontal straight line)
Price Level
Firms would produce
any level of output
demanded at the
existing price level.
P0
•
Y1
•
Y0
AS0
Y (GDP)
Why?
Firms had plenty of unused
capacity, unemployed workers
and resources.
Firms could expand
production without incurring
rising marginal costs.
This is a purely Keynesian
type assumption. Is it true
today? Maybe in some
industries.
MFC2007MFC2007,MFC2007,MFC2007MFC2007MFC2007
13 of 24
What does the Aggregate Supply Curve look like?
Price Level
Unless, the economy is in a serious recession and firms have a lot of
unused capacity, unit costs rise with output (Marginal Costs generally
increases as output increases) firms will produce more output only if prices
increase.
The AS curve is therefore upward sloping (except at very
levels of output).
AS1
•
P1
P0
In the short run firms
generally find that MC
increases as output increases
so they will increase
production only if they get
higher prices.
•
Y0
This is straight out of the
microeconomics of the firm.
Y1
Y (GDP)
MFC2007MFC2007,MFC2007,MFC2007MFC2007MFC2007
14 of 24
The slope of the AS curve is increasing as output rises:
- when output is low, firms typically have excess
capacity
 costs do not rise quickly
- when output is nearer Y*, costs rise as output rises
 firms need higher prices
EXTENSIONS IN THEORY 23-1
The Keynesian AS Curve
Copyright © 2011 Pearson Canada Inc.
15 of 24
23.3 Macroeconomic Equilibrium
E0 is the macroeconomic
equilibrium.
AD
AS
Price Level
Demand behaviour
is consistent with
supply behaviour
only at the
intersection of the
two curves.
E0
P0
P1
•
•
Y1
•
Y0
Y2
Real GDP
Copyright © 2011 Pearson Canada Inc.
16 of 24
Changes in the Macroeconomic Equilibrium
Demand shocks can either be expansionary or contractionary
- direction of AD shift
Supply shocks can either be expansionary or contractionary
- direction of the AS shift
In both cases, “expansionary” or “contractionary” refers to the
effect on equilibrium output.
Copyright © 2011 Pearson Canada Inc.
17 of 24
Aggregate Demand Shocks
Possible causes:
- ΔG > 0
AD1
Price Level
Demand shocks cause
P and Y to change in
the same direction.
AS
AD0
P1
P0
• E1
E0
•
- ΔI > 0
- ΔX > 0
Y0
Y1 Real GDP
- ΔC > 0
Copyright © 2011 Pearson Canada Inc.
18 of 24
AE
E1
•
•
Y1
Y
P
P0
E0
•
E1
•
AD1
AD0
Y0
Shifts in the AD Curve*
when P is constant
AE0 (P0) Any shock that increases
equilibrium GDP at a given price
level shifts the AD curve to the
right.
E0
Y0
AE =Y
AE1 (P0)
Y1
Y
Recall - interest rates
- wealth (non P related)
- confidence (expectations)
- foreign incomes
- exchange rates
- change in G
- etc.
The horizontal shift of the AD
curve is the simple multiplier
times the change in
autonomous spending.
MFC2007MFC2007,MFC2007,MFC2007MFC2007MFC2007
19 of 24
AE
AE =Y
E´1
• AE´1
AE1
AE0
E1
•
A
Y
The shock causes the AE
curve to shift upward, but
the rise in the price level
causes it to shift down.
E´1
• AD
1
With an upward sloping
AS curve, the multiplier is
smaller than the simple
multiplier.
•E
0
Y0
Y1
The Mechanics of an AD
Shift
Y´1
P
AS
E1
P1
P0
•
•
E0
Y0
AD0
Y1
Y´1
Y
Copyright © 2011 Pearson Canada Inc.
20 of 24
AD4
AD3
The steeper the AS
curve, the greater the
price effect and the
smaller the output effect.
AS
AD2
P4
Price Level
The effect of any given
shift of the AD curve will
depend on the slope of
the AS curve.
P3
•
AD1
AD0
•
•
P2
P1
P0
•
Y0
•
Y1
Y2 Y3Y4
Real GDP
Copyright © 2011 Pearson Canada Inc.
21 of 24
General case
AD4
The steeper the AS
curve, the greater the
price effect and the
smaller the output effect.
*
AS
AD3
P5
AD2
P4
Price Level
The effect of any given
shift of the AD curve will
depend on the slope of
the AS curve.
AD5
P3
•
AD1
AD0
•
•
P2
P0
•
•
Y0
Y1
Y2 Y3Y4
Y (GDP)
22 of 24
Aggregate Supply Shocks
Aggregate supply shocks
cause P and Y to change in
opposite directions.
Possible causes:
- Δ price of inputs
- Δ wages
- Δ technology
- Δ regulation
P
AS1
AS0
P1
P0
E1
•
• E0
AD
Y1
Y0
Copyright © 2011 Pearson Canada Inc.
23 of 24
*
Offsetting changes in wages
and productivity
An increase in wages
causes a negative supply
shock
An increase in productivity
causes a positive supply
shock
If wage rise at the same rate as
productivity increases then there
is no net effect
P
Negative supply shock if wages
rise faster than productivity
Positive supply shock if wages rise
more slowly than productivity
AS0
P0
MFC2007MFC2007,MFC2007,MFC2007MFC2007MFC2007
• E0
AD
Y0
24 of 24
A Word of Warning
Many economic events (especially changes in the world
prices of raw materials) cause both aggregate demand and
aggregate supply shocks.
The overall effect on the economy depends on the relative
importance of the two separate effects.
LESSONS FROM HISTORY 23-1
The Asian Crisis and the Canadian Economy
Copyright © 2011 Pearson Canada Inc.
25 of 24
The increase in the world price of oil from 2002 to 2008
was dramatic, but many observers were surprised at its
modest impact on the Canadian economy. For more
information on how changes in oil prices affect Canada,
and why the negative AS effect is smaller now than in
the 1970s, look for Oil Prices and the Canadian
Economy in the Additional Topics section of this book’s
MyEconLab.
www.myeconlab.com
Copyright © 2011 Pearson Canada Inc.
26 of 24
Copyright © 2011 Pearson Canada Inc.