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Chapter 12
Economic
Fluctuations
Aggregate Demand
This is the connection among:
Inflation
 Unemployment
 Level of spending real output in the Canadian
economy

The relationship between:

The general price and GDP (expenditure)

Real expenditure = Spending – (Spending / GDP Deflator)
Demand Curve
Downward Slope
As price goes up, demand goes down
 As price goes down, demand goes up

Change in Supply
on Equilibrium
Market Demand and
Supply Schedules for
Strawberries
Price Qd
Qs
$3.00
5 13 17
$2.50
7 11 15
$2.00
9
9
13
$1.50 11 7
$1.00 13 5
11
9
Market Demand and Supple Curves
for Strawberries
Price ($)
S0
3.00
S1
Surplus
2.00
a
b
1.00
0
D
1
3
5
7
9
Quantity
11
(millions of kilogram per year)
13
15
Change in Demand
on Equilibrium Price
Market Demand and
Supply Schedules for
Strawberries
Price
Qd
Qs
$3.00
5
9
$2.50
7
11 11
$2.00
9
13
9
$1.50 11
$1.00 13
15
17
7
5
Market Demand and Supple Curves
for Strawberries
($)
S
3.00
b
2.00
a
Shortage
D1
13
1.00
0
D0
1
3
5
7
9
Quantity
11
(millions of kilogram per year)
13
15
Movement Along the
Demand curve is Caused
by
Wealth

Assets such as money in bank accounts or
RSPS have unchanging nominal values



But their real value change
Real value for asset = nominal value / price level
Therefore, when price levels rise, the real value
of assets decreases, this gives people less
wealth and lower spending causing real
expenditure to decrease
Foreign Trade

As the Canadian price level rises, so do
the export prices, foreign markets will buy
less(decrease in export), but we will import
more (because their price level is lower
than ours). Hence, net export decrease
(X – M) and real expenditure decrease
Factors causing shifts in
the demand curve
Consumption
Disposable Income

Is the amount of money that can be spent,
the more spending the more real
expenditure(shift to the right).
Consumer expectations

Cause consumers to spend more or less
depending on if they predict the price will
rise or fall
Interest Rate

Play a roll when it comes for people making big
purchases, lower interest rates cause
consumers to borrow more and spend more
making total expenditures increase, and vice
versa
Investment

Investment refer to planned investments, not
unintentional changes in inventory
Rate of Return

Is the percentage change of the constant extra
profit provided per year generated by the
investment
Investment Demand

Relies on interest rates, production costs and
technological breakthroughs. As interest
rates decrease, companies will be able to
borrow more to pursue new investments.
Taxes may cause production cost to increase,
and fewer investments will be pursued(hence
less expenditure and a shift to the left).
Net Exports

When foreign incomes and exchange rate
change exports will be affected. If foreign
incomes rise, they will import more causing
us to export more (net exports increase).
When the dollar value increases their price
level will be increased and exports will
decrease.
Shifts in the Aggregate
Demand Curve
Aggregate demand increase, thereby
shifting the AD curve to the right / left,
with the following:

An increase/decrease in consumption due to
A rise/fall in disposable income
 A rise/fall in wealth
 An expected rise/fall in prices or incomes
 A fall/rise in interest rate


An increase/decrease in investment due to
A fall/rise in interest rates
 An expected rise/fall in profit
 A fall/rise in production costs

An increase/decrease in government
purchases
 An increase/decrease in net exports due to

A rise/fall in foreign incomes
 A fall/rise in the value of the Canadian dollar

Aggregate Supply
Aggregate Supply

The relationship between the general price
level and real output produced in the
economy
Aggregate Supply Curve

The relationship between the general price
level and real output expressed as a graph
Change in Aggregate
Supply
Aggregate supply factor

Variables that change total output at all
price levels
Input Prices

Short-run increase in aggregate supply

An increase in total output at all price levels,
with no change in potential output
Resource Supply

Long-run increase in aggregate supply


Productivity


Is the real output produced per unit of input over a
given period
Specifically labor productivity for example
would be calculated as follows

•
An increase in total and potential output at all price
levels
Labour productivity =
Real output
Total hours worked
Here we divide the nations real output by the
total number of hours worked by its labour
force
Government Policies
Government policies can also influence
aggregate supply through their effects on the
business environment in an economy
 Example


Suppose taxes rise for businesses and households.
Because the after taxes on supplying economic
resources are reduced, business and households
may reduce the resources they supply at every
price level. As a result real output falls, causing a
long-run decrease in aggregate supply
Equilibrium
Aggregate Demand and Supply

An economy’s equilibrium price level and
real output occur at the intersection of the
aggregate demand and aggregate supply
curves
Inventory Changes
Unintended changes in inventories cause
price levels and real outputs to reach
equilibrium. There are two possible changes:
an inventory increase or decrease

Results of a inventory increase cause a surplus
and the prices of individual products decrease,
pushing down the general price level. This is
known as a positive unplanned investment. The
decrease influences both households and
businesses to buy and creates equilibrium


Results of an inventory decrease cause a
shortage. This leads to a decrease in inventory
and therefore the prices rise, this is known as
negative unplanned investment. Buyers
decrease spending, businesses raise real
output and this creates equilibrium
The role of unplanned investment players a
central role of stabilizing the economy. It is
identical to the discrepancy between
aggregate demand and aggregate supply.
(Has a monetary value)
Injection and Withdrawals
Injection

Are additions to an economy’s income spending
stream. There are three flows



Investment (I)
Government Spending (G)
Exports (X)
Withdrawals

Are deductions from an economy’s incomespending stream. There are three flows:



Saving (S)
Taxes (T)
Imports (M)
To understand we look at related pairs of
injections and withdrawals

Investment and Savings

Households provide personal savings into the
loanable funds market. Most of these funds are
borrowed by businesses for investment.
However the amount saved and the amount
invested in an economy are not equal for three
reasons.



Companies keep a portion of their profit to
reinvest
Government also borrow
Foreign exchange flow must also be considered

Government Purchases and Taxes


Exports and Imports


Governments purchases usually exceed taxes,
and to make up for the discrepancy governments
borrow money from financial markets. In the odd
case when taxes exceed government spending
they can use the money to pay off debt
Foreign lending tends to be greater than foreign
borrowing, therefore the surplus in lending makes
up for the short fall in net exports
Total injections and withdrawal

Have an important connection that applies when
an economy is at equilibrium. Total injections are
the sum of I + G + X and total withdrawals are the
sum of S + T + M. This determines the state of the
economy
Equilibrium vs. Potential
Output
If an economy’s equilibrium occurs at its
potential output, then unemployment at
equilibrium equals the natural unemployment
rate
Recessionary Gap

Occur when the amount by which equilibrium
output falls short of potential output
Inflationary Gap

Occur when the amount by which equilibrium
output exceeds potential output