Transcript Aggregate Demand - Spring Branch ISD

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From simple demand and supply in chapter 3to aggregate demand and aggregate supply
Similar principles:
P goes up, D goes down
PL goes up, AD goes down
Aggregate Demand
Youtube video
Aggregate Demand and Supply
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Chapters 9 and 10:
fixed price level
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Chapter 11: variable
price level
Aggregate Demand
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Schedule or curve that shows the amount of
real output that buyers collectively desire to
purchase at each possible price level
Inverse
PL increase, quantity of real GDP demanded
decreases
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AD most important factor PL (movement)
other reasons why AD increases/decreasesshift
AS most important factor PL (movement)
other reasons why AS increases/decreasesshift
AD
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1. change in consumer
spending
Change in investment
spending
Change in Government
spending
Change in net export
spending
AS
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Change in input prices
Change in productivity
Change in legalinstitutional
environment
Aggregate Demand Curve
Why downward slope?
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Single product demand:
income effect and
substitution effect
When price of
individual product falls,
consumers have more
money, buy more
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Aggregate demand:
when general price level
decreases, there is less
nominal income flowing
to suppliers in form of
wages, rents, interests,
etc.
This means people as a
whole are earning less!
Substitution effect
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Works for individual
item
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There is no overall
substitution effect
among domestically
produced goods when
the price level falls
3 Reasons for downward slope of
aggregate demand (cause a
movement, not shift b/c they relate
to change in PL)
Real-balance effect
Interest-rate effect
Foreign purchase effect
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Real-Balances Effect
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Change in price level produces a real-balance
effect
Higher price level reduces real value or
purchasing power of people’s savings
Example- you might buy new car if you have
50,000 in savings, but with inflation if the
money is only worth 30,000 you might hold
off
Interest-rate effect
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When price level rises, consumers need more
money for purchases and businesses need
more money to meet payroll, etc.
Increase in demand for money will drive up
the price paid for its use---- INTEREST
Increasing demand for money and interest rate,
a higher price level reduces the amount of real
output demanded
Foreign Purchases Effect
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Rise in price level reduces the quantity of U.S.
goods demanded. (foreigners buy fewer
American goods and Americans buy more
foreign goods)
Determinants of Aggregate Demand
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Causes aggregate demand curve to shift (other
than change in price level…movement)
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1.
2.
3.
4.
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change in consumer spending
change in investment spending
change in government spending
change in net export spending
Change in consumer spending
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1.
2.
Several factors other than a change in price level
may change consumer spending and thus shift
aggregate demand curve
Consumer wealth (example– doing well in stock
market)
Consumer expectations- when people expect their
future incomes to rise, they spend more of current
income, people expect huge inflation, will buy more
now, lower future income expectations or lower
prices in future will decrease AD
Changes in investment spending
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a.
b.
c.
d.
Real interest rates- increase in money supply lowers
the interest rate, increasing investment, dec. in
money supply, raises interest rate, dec AD
Expected Returns- higher returns increase AD
Expectations about future business conditions
Technology
Degree of excess capacity- rise in unused capital
will reduce expected rate of return and reduce AD
Business taxes- AD decline if they increase and AD
will increase if they decrease
Government Spending
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Increase in Gov spending will shift AD to right
Change in net export spending
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1.
2.
Greater level of US exports = increase AD,
lower imports- increase AD
These changes are not associated with PL!
What might change net export other than PL?
National income abroad- rising NI abroad
encourages foreigners to buy more products,
some of which are US made (increase AD)
Exchange rates- deprecation of dollar
increases US exports- AD shift to right
Aggregate Supply
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Schedule or curve showing the level of real
domestic output that firms will produce at each
price level
Has 3 distinct segments or ranges- horizontal
range, intermediate range, vertical range (pg
210)
Aggregate Supply
Horizontal range
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Includes only levels of real output that are
substantially less than the full-employment
output
Economy is in a recession or depression and
large amounts of machinery and equipment
and unemployed workers available for
production
If real output falls, product and resource prices
will not move downward
Intermediate (upsloping range)
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Expansion of real output is accompanied by
rising price level
Vertical range
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Increases of price level in this range will
produce no additional output since the
economy already is operating at its full
capacity
Determinants of Aggregate Supply
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1. change in input price
2. change in productivity
3. change in legal-instituted environment
Change in input price
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Higher input price increase per-unit production costs and
reduce aggregate supply
Factors that influence input prices:
* Domestic resource availability- increases in supply of
domestic resources will lower resource prices, reduce per-unit
production costs, and shift aggregate supply curve to the right
A. Land- expansion will increase supply, vice versa
B. labor- increase in labor reduces price of labor, shifting labor
to right
C. Capital- replacing old capital with new- shift to right,
destruction of capital due to war- shift to left
D. Entrepreneurial ability-
Price of Imported Resources
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Decrease in price of imported resources
increase U.S. aggregate supply, increase in
their price reduces U.S. aggregate supply
Market Power
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Change in degree of market power- the ability
to set above-competitive prices can affect input
prices and aggregate supply
Example- OPEC
Productivity
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(second major determinate of AS)
A measure of the relationship between a
nation’s level of real output and the amount of
resources used to produce it.
Productivity = total output/ total input
Legal-Institutional Environment
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Business taxes and subsidies
Government regulation
Intersection of AD and AS
determines the economy’s
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Equilibrium price level and equilibrium real
output
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AD/AS curve may intersect in different ranges
(horizontal, intermediate, vertical)
Changes in Equilibrium
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How will a change in AD demand impact the
economy? It depends on where we are
(horizontal, intermediate, vertical)
Increase in AD in horizontal range- no
inflation, intermediate- inflation (demand-pull
inflation) vertical (demand-p`ull inflation)
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In the horizontal range of AS, the full strength of the
multiplier works!
In contrast, if the economy is in the intermediate or
vertical range of the AS curve, part or all of any
initial increase in AD will be dissipated in inflation
and therefore will not reflect an increase in real
output
Any initial increase in AD, the resulting increase in
real GDP will be smaller the greater the increase in
PL
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Decreases in AD in horizontal range signal
recession and cyclical unemployment
Real output takes the full brunt of the decline
in AD because it occurs in the horizontal range
of AS where sometimes there is no price
flexibility
Why?
Numerous reasons for downward
price inflexibility
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Wage contracts
Morale, effort, productivity- efficiency wages- wages
that elicit maximum work effort and thus minimize
labor cost per unit of output- some employers are not
willing to lower wages and morale
Minimum wage
Menu costs- cost of printing new catalogs, etc when
changing price
Fear of price wars