Transcript P 1

Aggregate Demand
• Aggregate demand is the total demand in an
economy for all the goods and services produced.
• The aggregate demand schedule is a schedule
relating the total demand for all the goods and
services produced in an economy to the price
level.
• The aggregate demand curve slopes down.
Aggregate Demand
P
Note that at P2, the higher price level,
aggregate demand equals Y1, but at P1,
the lower price level, aggregate demand
equals Y2.
P2
P1
AD
0
Y1
Y2
Y
Aggregate Demand
• Aggregate demand slopes down because:
– As the price level increases, the purchasing power
of real wealth decreases, resulting in less spending
and lower Y.
– As the price level increases, the real money supply
decreases, pushing up interest rates.
– As the domestic price level increases, foreigners
buy less of our goods and services.
Aggregate Demand
AS
AE
AE2(P1)
B
We begin at point A where income
is Y1 and the price level is P2.
AE1(P2)
Y1 and P2 comprise one point on
the aggregate demand curve, AD.
A
0
P
Y1
P2
A
P1
Y2
Y
At P1, equilibrium income is Y2.
B
AD
Y
0
Y1
Y2
We let the price level fall to P1. At
the lower price level, purchasing
power increases, causing aggregate
expenditures to shift up from AE1 to
AE2.
Y2 and P1 comprise another point on
aggregate demand curve, AD.
Changes in Aggregate Demand
• Aggregate demand increases when people
want to buy more goods and services and
decreases when people want to buy less.
• There are two types of aggregate demand
change that can occur
– A change in aggregate demand caused by a
change in the price level.
– A changes in aggregate demand caused by events
not related to a change in the price level.
Moving along the AD Curve
• Changes in aggregate demand caused by a change
in the price level are shown by a movement along
the aggregate demand schedule.
– Increases in the price level decrease aggregate demand
– Decreases in the price level increase aggregate
demand.
Moving along the AD Curve
P
P2
Note that at P2, the higher price level,
aggregate demand equals Y1, but as the
price level falls to P1, the lower price level,
aggregate demand rises to Y2.
P1
AD
0
Y1
Y2
Y
Shifting the AD Curve
• A change in any of the variables in the AE/AS
model except the price level shifts AD.
• Examples:
–
–
–
–
–
An increase or decrease in investment
An increase or decrease in consumption
An increase or decrease in taxes
An increase or decrease in government spending.
An increase or decrease in the money supply
Shifting the AD Curve
P
Increases in AD are shown by shifting
the AD curve from AD1 to AD2. Note
that at the price level P1, aggregate
demand on AD2 is greater than on AD1.
P1
Decreases in AD are shown by shifting
the AD curve from AD2 to AD1. Note
AD2 that at the price level P , aggregate
1
AD1
demand on AD1 is less than on AD2.
0
Y1
Y2
Y
Shifting Aggregate Demand
AS
AE
AE2(P1)
B
AE1(P1)
A
0
P
P1
Y1
A
Y2
Y
AD1
Y1
Increases in spending shift aggregate
expenditures from AE1 to AE2.
Increases in spending shift aggregate
demand from AD1 to AD2.
B
0
Y2
Y
An increase in spending that is NOT
caused by a change in the price
level causes the aggregate demand
curve to shift.
AD2
Decreases in spending shift aggregate
expenditures from AE2 to AE1.
Decreases in spending shift aggregate
demand from AD2 to AD1.
Aggregate Demand and the Multiplier
AS
AE
AE2(P1)
B
AE1(P1)
A change in spending that is not
caused by a change in the price level
shifts the aggregate demand curve.
A
0
P
P1
Y1
Y2
When aggregate expenditures rise,
income increases by more than the
increase in expenditures.
Y
Note that the price level is P1 at both
Y1 and Y2.
C
The distance Y1Y2 = CD reflects the
impact of the multiplier effect in the
D
AD1
0
Y1
Y2
Y
AD2
aggregate demand model.
Practice
• How does a lower price level change aggregate
demand? Is this a shift in AD or a movement
along the AD schedule?
• What will cause the AD schedule to shift up? List
three real world examples of such an AD shift.
• What will cause the AD schedule to shift down?
List three real world examples of such an AD
shift.
Aggregate Supply
• Aggregate supply is the total quantity of goods
and services produced in an economy.
• The aggregate supply schedule is a schedule
relating the total supply of all the goods and
services produced in an economy to the price
level.
Short-Run Aggregate Supply Curve
• The short run aggregate supply curve shows how
aggregate supply increases as the price level rises
but factor costs do not change.
– The short run is defined as that period of time over
which nominal factor costs do not change.
• Nominal factor costs include wages, interest paid on
loans, and the cost of plant and equipment.
• The short run aggregate supply curve may be flat
or upward sloping.
Short Run Aggregate Supply Curve
P
AS
Aggregate supply is drawn as a horizontal
line over the range of output that is far
below the economy’s full capacity. Over
this range, 0Y1, there is no shortage of
inputs and the economy can expand
without a price level increase.
As the economy approaches full capacity,
Yfe, employers have difficulty finding
skilled workers and must hire less
productive employees. The price level
rises due to diminishing returns. This is
reflected in an upward sloping AS curve.
0
Y1
Yfe Y
At Yfe, we have full employment of all
resources. Output is fixed.
Aggregate Supply and the Price Level
P
AS
A fall in the price level from P2 to P1
causes a decrease in profits, given
fixed resource costs.
P2
Lower profits are an incentive for lower
levels of production and output.
P1
A rise in the price level from P1 to P2
results in an increase in profits, given
fixed resource costs.
Higher profits are an incentive for
higher levels of production and output.
0
Y1
Yfe
Y
Shifting the Aggregate Supply Curve
AS1
P
AS2
AS3
A shift in the aggregate supply curve
represents any change in aggregate
supply that is not caused by a change
in the price level.
Shifts in aggregate supply are caused
by events such as a change in the
overall level of resource productivity
and changes in resource availability.
Tax policy also can affect AS.
Increases in AS are shown by a shift
of the curve to the right.
0
Y
Decreases in AS are shown by a shift
of the curve to the left.
Practice
• How does a lower price level change aggregate
supply? Is this a shift in AS or a movement along
the AS schedule?
• What will cause the AS schedule to shift up? List
three real world examples of such an AS shift.
• What will cause the AS schedule to shift down?
List three real world examples of such an AS
shift.
Equilibrium in the AD/AS Model
• Equilibrium in the AD/AS model occurs where
aggregate demand just equals aggregate supply.
• It is a stable equilibrium.
– If AD>AS, the price level rises and Y falls
– If AD<AS, the price level falls and Y rises.
Equilibrium in the AD/AS Model
P
AS Equilibrium occurs at the point E where the
price level is P1 and output is Y1.
At this point, aggregate demand is just
equal to aggregate supply. All the goods
and services produced are demanded by
the members of the economy.
P1
E
AD
0
Y1
Yfe
Y
The equilibrium is stable. If the economy is
not at equilibrium, there are forces that
push AD and AS towards equilibrium.
Equilibrium in the AD/AS Model
P
Equilibrium occurs at point E, where the
price level is Pe and output is Ye.
AS
A
Deflationary Gap
B
At price levels below Pe, AD>AS by the
amount CD. Firms will not be able to meet
demand with current production levels,
resulting in a decline in inventories and a rise
AD in both production and the price level.
E
Pe
C
0
At price levels above Pe, AS >AD by the
amount AB. Firms will not be able to
sell all the goods they produce, resulting
in an increase in inventories and a decline
in both production and the price level.
D
Inflationary Gap
Ye
Y
Changes in Aggregate Demand
P
AS
Increases in aggregate demand shift the
AD curve to the right. Both income and
the price level rise.
P2
P1
Decreases in aggregate demand shift the
AD curve to the left. Both income and
the price level fall.
B
A
AD2
AD1
0
Y1
Y2
Y
Changes in Aggregate Supply
P
AS1
AS2
A
P2
Decreases in aggregate supply shift the
AS curve to the left. Income falls
and the price level rises.. We move from
point B to point A.
B
P1
AD
0
Y1
Y2
Increases in aggregate supply shift the
AS curve to the right. Income rises and
the price level falls. We move from
point A to point B.
Y
Practice
• Assume the economy is at full employment and
increase AD. What happens to P and Y?
• Now assume the economy is at full employment
and increase AS. What happens to P and Y?
• If you were in charge of increasing Y while
avoiding inflation, which curve would you want
to shift? How would you do it?
Practice
• Explain and show graphically what will happen to
P and Y under the following circumstances:
(Assume the economy is neither in a recession or
at full employment)
–
–
–
–
–
–
Taxes on consumers fall
Taxes on businesses fall
Interest rates rise
Business optimism falls
Oil prices double
People begin to save more at every rate of interest
Practice
• In the Great Depression, the price level and GDP
fell. What shift or combination of shifts in AD
and AS would best describe the Great
Depression?
• Currently, we are in an economic expansion. Is
our expansion caused by changes in AD or AS?
Explain your answer.