Transcript Chapter 10 Aggregate Demand & Aggregate Supply

1. Define AD & AS.
AD – AQD [RGDP] desired by the private, public, & foreign
sector at various PLs [inverse] [Everyone’s demand for everything]
AS – AQS [RGDP] firms will supply at various PLs [direct]
2. Three reasons for the down-sloping AD curve
a. interest rate effect b. real-balances effect c. foreign purchase effect
3. Know the three ranges of the AS curve.
4. Predict effects of an increase in AD in
Keynesian, intermediate, & classical ranges.
5. Predict effects of an increase/decrease in AS
on output and price level.
6. Know the four AD shifters [C+Ig+G+Xn].
7. Know the three AS shifters [“REP”].
8. Explain the ratchet effect of a decrease in AD.
9. Compare the Classical/Keynesian Schools of Economics.
[Demand (AD) for everything by everyone] or
[Amount of goods & services that will be demanded at
various price levels by the private, public, and
foreign sectors]
[AQD will be greater at lower price levels]
[amount of goods and services that will
be produced by firms at various price levels]
[AQS will be greater at higher price levels]
Aggregation
– combining all prices into a single
aggregate price level and – combining all quantities
into aggregate quantities [AQS or real GDP]
Price
Level
ADCIG-XnLRAS
SRAS
[REP]
[Production cost]
PLe
Ye RDO [Real Domestic Output]
[C+Ig+G+Xn] When one of these variables change, either
positively or negatively, the AD curve will move right or left.
Caused by a “Change in PL”
Macro Law of Demand
[Inverse]
AD
PL1
Macro Law of Supply
[DIRECT ]
AS
PL1
PL2
PL2
AQS2 AQS1
AQD2
AQD1
AQD or AQS is a point on the AD or AS curve [particular PL]
AD or AS is the whole curve and represents all price levels.
[Bunch of AQDS or AQS strung together on the same curve]
AD
PL1
PL2
PL
AQD
AQD1
AQD2
There go some
of my profits!
AS
PL1
PL2
[DIRECT]
AQS2 AQS1
AS
PL2
PL1
[DIRECT ]
AQS1 AQS2
PL
CIG-X
AD Shifters
[C+Ig+G+Xn]
Consumption
Investment (gross)
Government Spending
[infrastructure, military
spending, health care]
Net eXports
Y indicates 3 things:
1. Output[GDP]
2. Income
3. Unemployment
YR – Recession gap
YI – Inflation gap
Y* – Full Employ.
LRASSRAS2
SRAS1
AD
2
AD1
SRAS2
AD2
AS Shifters
[REP]
Resource cost
Environment
103
YR Y* YI
[legal-institutional]
RGDP
Aggregation – we are
combining all prices into
price level & combining all
quantities into Real GDP(Y).
1. Subsidies,
2. Business taxes,
3. Business regs.
Productivity
Don’t confuse FE output
with the economy’s
maximum output, which
is the larger output that
would be produced if
everyone were forced
to work as much as
possible.
Price
Level
ADCIG-XnLRAS
SRAS
[REP]
[Production cost]
PLe
Ye RDO [Real Domestic Output]
[C+Ig+G+Xn] When one of these variables change, either
positively or negatively, the AD curve will move right or left.
• Short-Run
– Period of time where
input prices [wages]
are sticky and do not
adjust to changes in
the PL
– In the short-run, the
level of Real GDP
supplied is directly
related to the PL
• Long-Run
– Period of time where
input prices [wages]
are completely
flexible and adjust to
changes in the PL
– In the long-run, the
level of Real GDP
supplied is
independent of the PL
[caused by “C+Ig+G+Xn”]
AD1
AD2
LRAS
SRAS
Increase in AD
Price Level
1. Increase in Consumption
2. Increase in Investment
3. Increase in Gov. spending
A. On military spending
B. On the infrastructure
C. On health care
4. Increase in Net exports [Xn]
A. Dollar depreciates
B. Trade partners Y’s rise
YR
YF
Real Domestic Output, RGDP
[caused by “C+Ig+G+Xn”]
AD2
AD1
LRAS
SRAS
Price Level
Decrease in AD
1. Decrease in Consumption
2. Decrease in Investment
3. Decrease in Gov. spending
A. On military spending
B. On the infrastructure
C. On health care
4. Decrease in Net exports [Xn]
A. Dollar appreciates
B. Trade partners Y’s fall
YR
YF
Real Domestic Output, GDP
The amounts of real output that buyers
[householders, businesses, government, & foreigners]
desire to purchase
at each possible price level.
Or, the “demand for everything by everyone”.
AD curve is downsloping due to:
•Real Wealth [Money-balances] Effect
[monthly flow of money and stock of accumulated
savings balances like bonds & CDs “really” buy more]
•Interest-Rate Effect - businesses invest more
•Foreign Purchases Effect - foreigners buy more
AD
PL1
PL2
AQD1 AQD2
[There is no income or substitution effect.]
[You can’t substitute for the whole economy]
Macro Law of Demand
[cause]
[effect]
PL decr; AQD incr.
PL incr; AQD decr.
“AD” refers to whole curve.
“AQD” is a pt on the curve
based on a particular PL.
AD
Reasons For Downsloping “AD” Curve
[if PL decreases, this happens]
1. Interest Rate Effect – more Ig
2. Real Wealth Effect – more “C”
3. Foreign Purchase Effect - foreigners buy more
PL1
Change in AQD
PL
AQD
1. Price Level change
2. Movement [up or down
the AD curve
3. Pt to pt [along the AD curve]
PL2
Inverse
relationship
2
AQD
1 AQDcurve”.
“AD” refers to the
“whole
[“all PLs”]
“AQD” refers to a “point on the curve”
based on a “particular price level.”
C
Consumption
Mariah Carey Concert
1. “Non price Level” change-either C, Ig, G, or Xn
2. “Whole AD curve” shifts
[There is a change in AQD but it is not caused by
a change in price level.]
AD2
AD
1
AD3
Ig
G
PL
Let there be more
military weapons
XN
Chevy
Ferrari
[Exports-Imports]
AQD3 AQD1 AQD2 RDO
AD1 AD2
PL
Change in Consumer Spending
Consumer Wealth [increases/decreases]
[stocks/houses] [stable prices]
Consumer Expectations [about future prices (increases/decreases)
Consumer Expectations about future income [positive/negative]
Consumer Indebtedness [low/high]
Personal Taxes [increase/decrease]
Real Interest Rate [stable prices] [increase/decrease]
High Debt
Change in Investment Spending
Real Interest Rates [stable prices] [increase/decrease]
[Positive/Negative] Profit Returns
[Business taxes [increase/decrease]
[Depleted/Excess] inventory stockpiles in the supply chain
[continued]
Government Spending
[purchases]
[either [increases/decreases] on [infrastructure, military, health care, etc.]
Net Export Spending
AD1 AD2
• National Income Abroad
[either increases or decreases]
PL
• Exchange Rates
[Depreciation-increases AD; Appreciation-decreases AD]
More Exports
Fewer Exports
[Our products are cheaper]
[Our products are more expensive]
PL
LRAS
SRAS
AD
103
Y* Real GDP
6%
• While it may appear contradictory to talk
about producing beyond the economy’s
potential, remember that potential output
does not mean zero unemployment.
• Rather, it means that the actual
unemployment rate equals the natural
rate of unemployment, approximately
94%-96% of the labor force working.
 That is, even in an economy producing its potential output,
there is some unemployed labor & unused production capacity.
 Potential GDP can be thought of
as the economy’s normal capacity.
LRAS SRAS
PL2(106) AD1
AD2
AD3
PL1(103)
PL3(100)
YR Y*F Yi
YA YP YA
9% 6% 3%
 Firms and workers are able, in the short run,
to push output beyond the economy’s potential.
*In the LR, the level of RGDP supplied is independent of PL.
*In the SR, the level of RGDP supplied is dependent of PL.
AD1
Price
Level AD3
PL
AQD
SRAS
AD2
CIG-X
Surplus
Shortage
AQD
Raise PL
Y3 Y Y2
Real Domestic Output
“AS” refers to the “whole AS curve” & refers to “all price levels”
“AQS” refers to a “point on the AS curve” & refers to a “particular price level”
Change in “AQS”
PL2
1. Price Level change
2. Movement (up/down) “AS” curve)
3. Point to point (along “AS” curve)
AS
PL1
AQS1 AQS2
Reasons For Upsloping “AS” Curve
1. There is increasing opportunity cost if firms don’t produce.
2. Current producers produce more [overtime/more shifts]
3. New producers are attracted to the market.
Change in AS
1. “Non price level change”. Either R,Anything
E, or P
that lowers
2. “Whole AS curve” shifts.
the cost of production
3. AQS changes but is not caused bywill
a change
PLright.
shift in
AS
AS Shifters(REP)
1. Resource cost
2. Environment [legal-institutional
Increase in
environment for businesses change,
the affecting
availability
of Resources
production
costs
[subsidies, bus. taxes, regulations]
3. Productivity
PL
1. Lower business taxes
2. Decrease in regulations
3.
AS3 AS1 AS2
So – AS Shifters are
REP
You save money. We don’t require
dental or medical insurance. You
don’t have to pay us a pension
and we don’t take sick days. And
– we can dance.
Increase in subsidies
Environment
[Legal-institutional]
AQS3 AQS1 AQS2
Increase in Productivity
[Recessionary Gap, Inflationary Gap, or no gap]
AD1
110
LRASSRAS
AD3
103
101
AD2
Recess
Gap
Inflat
Gap
[5%(“real”) cyclical unemployment]
10% (5x2%=10%) Recess. GDP Gap
SR – output [product]
11% 6% 1% [10%(5x2%) Inflationary GDP Gap
YR Y* YI
YA YP YA
$10 $11
$9 increase/decrease
prices
but input
[wages] prices remain fixed in the presence of
unanticipated inflation/disinflation [“sticky”]
LR –
both output
[product] and
input
[wages]
prices change.
[caused by “REP”]
Decrease in AS [“REP”]
Resource Cost
1. Increase in resource cost
AD
SRAS3SRAS
LRAS
1
SRAS2
Environment [legal-institutional]
PL
2. Decrease in subsidies
3. Increase in bus. regulations
4. Increase in business taxes
Productivity
5. Decrease in productivity
Increase in AS [“REP”]
Resource Cost
1. Decrease in resource price
Environment [legal-inst.]
Regulations place compliance costs on
2. Increase in subsidies
businesses and reduce the SRAS.
3. Decrease RGDP
in bus. regs.
Real Domestic Output,
RGDP
Ex: To reduce sulfur dioxide emissions, factories 4. Decrease in bus. taxes
have to pay for smokestack scrubbers which
Productivity
5. Increase in productivity
mean less money to increase output.
AD
SRAS2
SRAS1
PL2
PL1
Shortage
Y2 Y 1
Real GDP
AD
SRAS1
SRAS2
PL1
Increase in
Productivity
Surplus
PL2
Y2 Y2
Real GDP
A 1% increase in productivity can eliminate 1.2 million jobs.
LRAS
Price
Level
SRAS
AD2
AD
PL2[106]
[Production cost]
E2
What if we have
unanticipated inflation?
What happens in SR to
output, employment,
and price level?
PL1[103]
Y
YI
RGDP
Price
Level
PL2[106]
LRAS
AD2
AD
E3
SRAS2
SRAS1
[Production cost]
PL1[103]
With unanticipated inflation
what happens to output,
employment and price level
in the LR?
RGDP
Y
There is a Short Run Equilibrium [AD=SRAS]
and a Long Run Equilibrium [AD = LRAS].
LRAS
Price
Level
AD1
SRAS
[Production cost]
With unanticipated
disinflation, what happens
to output, employment,
and price level in the SR?
AD2
PL1[103]
PL3[101]
E2
YR Y
RGDP
LRAS
AD
SRAS1
[Production cost]
SRAS2
PL1[103]
PL3[101]
E3
Y
With unanticipated
disinflation, what happens
to output, employment,
and price level in the LR?
RGDP
LRAS
AD
SRAS
The LRAS curve is not
influenced by PL.
103 PL
Output at
Full Employment
The SRAS curve is
influenced by PL and
slopes upward because
of sticky-wages and
sticky-prices.
Y* Quantity of Output
LRAS
Price
Level
SRAS
AD1
AD2
PLe
Surplus
PL2
YR Ye
Quantity of Output
[Stagflation]
Price
Level
AD
LRAS
SRAS2
SRAS
1
110
This created cognitive
dissonance among many.
Ple[103]
10% 6%
YR YF
RDO
1. The process of combining all individual product prices and
quantities into a single unit is (deduction/conglomeration/aggregation).
2. The AD curve shows the amount of (real/nominal) domestic
output which will be purchased at each possible (price/price level).
3. The AD curve is always (up/down) sloping & shows a(an)
(direct/inverse) relationship between output & (price/price level).
4. The income & substitution effects (do/do not) apply to the AD
curve. The 3 explanations for the downsloping AD curve are the
interest rate effect, foreign purchase effect, & (econ/real-balances) effect.
AD
Change in AQD
Price Level Change
Point to Point movements
PL1
PL
AQD
PL2
AQD1
AQD2
AD
PL1
Real Wealth [Money-balances] Effect –
PL2
economy’s monetary wealth. If we buy
QD1 QD2
a fixed bundle of goods & services every month
(food/clothing/ shelter), at lower
prices, it now takes less money.
money. Our accumulated savings
balances [401k, CDs, bonds] will
purchase more.
Market Basket
Interest Rate Effect – lower interest rates
increase investment and consumption.
Foreign Purchase Effect – with
lower U.S. prices, both Americans &
foreigners buy more American goods.
5. The interest rate effect suggests that an increase in the PL
will (incr/decr) the demand for money, (incr/decr) interest
rates and (increase/decrease) consumption and investment
which would cause a(an) (increase/decrease) in (AD/AQD).
6. The real-balances effect indicates a higher price level will
(increase/decrease) the real value of money, (increase/decrease)
consumption, and therefore (increase/decrease) (AD/AQD).
7. The foreign purchase effect suggests that an increase in PL
relative to other countries (increase/decrease) our exports and
(incr/decr) our imports which would (incr/decr) (AD/AQD).
AD
PL2
PL1
Lower PL
Higher PL
AQD2
AQD1
AD1
110
SRAS2 SRAS
SRAS3
LRAS
AD3
AD2
103
101
Recess
Gap
[5%(“real”) cyclical unemployment]
10% (5x2%=10%) Recess. GDP Gap
11%
YR
YA
$9
Inflat
Gap
6%
Y*
YP
$10
1% [10%(5x2%) Inflationary GDP Gap
YI
YA
$11
Input prices have responded to unanticipated changes in output
prices in LR. [They respond to unanticipated inflation or disinflation.
Two sets of prices are changing in LR - output and input.
[C+Ig+G+Xn]
Consumer Spending Increases
AS
1. Aggregate wealth increases independent of PL
[stocks, bonds, land, houses, etc.]
2.
3.
4.
5.
Expectations of surging future inflation
Consumer indebtedness is fairly low
Consumer taxes are decreased
PL
Interest rates are decreased [independent of PL]
Investment Spending Increases
1.
2.
3.
4.
AD1
AD2
Y1 Y2
Interest rates are decreased [independent of PL]
Positive profit expectations
Factory inventories are down
100 Bases May
*Business taxes are reduced [*will also shift AS]Face Closure
Government Spending Increases
Military base cuts
Government spending increases on health care,
would start in 2010.
Health care, infrastruc., military
military bases, infrastructure, etc.
100
of the nation’s
425 bases would be
Net Export Spending Increases
1. Foreign incomes increase [will buy more there andclosed,
here] saving over
$75 billion annually.
2. Dollar depreciates
[our exports are cheaper]
Resource Cost Decrease (domestic)
1. Land – new raw materials (oil) are found.
2. Labor–labor force increases or wages decrease.
3. Capital stock or entrepreneurial ability increases.
4. The number of sellers of resources increase.
AD
AS1 AS2
PL1
PL2
Resource Cost Decrease (overseas)
1. Imported resources decrease in price.
2. Dollar appreciates [foreign inputs are cheaper].
3. OPEC nations cheat by producing more oil.
Environment
[Legal-Institutional Environment for businesses change]
1. Subsidies are increased.
2. Regulations on businesses are decreased.
3. *Business taxes decrease.
Productivity Increases
Technological breakthrough leads to an increase
in productivity [more outputs from same inputs].
*Notice that a decrease in business taxes increases
both AD & AS.
Y1 Y2
Change in AS
1. “Non price level change”. Either R, Anything
E, or P
that lowers
2. “Whole AS curve” shifts.
the cost of production
shiftinAS
3. AQS changes but is not caused by will
a change
PL right.
AS Shifters(REP)
1. Resource cost
2. Environment [legal-institutional
environment for businesses change,
Increase in the affecting
availability
of Resources
production costs.
[subsidies, bus. taxes, regulations]
3. Productivity
PL
1. Lower business taxes
2. Decrease in regulations
3.
AS3 AS1 AS2
So – AS Shifters are
REP
You save money. We don’t require
dental or medical insurance. You
don’t have to pay us a pension
and we don’t take sick days. And
– we can dance.
Increase in subsidies
Environment
[Legal-institutional]
AQS3 AQS1 AQS2
Productivity increase
Increase in AD
[caused by “C+Ig+G+Xn”]
Increase in AD
1. Increase in Consumption
a. aggregate wealth increases
AD1
b. expected increase in inflation
AD2
LRAS
c. positive future income
Price Level
d. low consumer debt
e. decrease in consumer taxes
f. decrease in interest rates
2. Increase in Investment
a. decrease in interest rates
b. positive profit expectations
c. inventories are low
d. *business taxes are reduced
3. Increase in Government spending
a. on the military
b. on the infrastructure
c. on health care
4. Increase in Net exports [Xn]
A. Dollar depreciates
B. Trade partners incomes rise
YR
YF
Real Domestic Output, GDP
SRAS
Decrease in AD
[caused by “C+Ig+G+Xn”]
Decrease in AD
1. Decrease in Consumption
a. aggregate wealth decreases
AD2
b. expected decrease in inflation
AD1
LRAS
c. negative future income
Price Level
d. large consumer debt
e. increase in consumer taxes
f. increase in interest rates
2. Decrease in Investment
a. increase in interest rates
b. negative profit expectations
c. excess inventories
d. *business taxes are increased
3. Decrease in Government spending
a. on the military
b. on the infrastructure
c. on health care
4. Decrease in Net exports [Xn]
A. Dollar appreciates
B. Trade partners incomes fall
YR
YF
Real Domestic Output, GDP
SRAS
Increase in AS
[caused by “REP”]
Increase in AS [“REP”]
AD
Resource Cost [domestic]
a. More land, labor,
capital & entrepreneurs
b. # of sellers increase
c. Hiring fewer union PL
workers
Resource Cost [overseas]
c. Imported input prices decrease
d. Dollar appreciates
Environment [legal-institutional]
a. Increase in subsidies
b. Decrease in bus. regulations
c. *Decrease in business taxes
Productivity
Increase in productivity
AS1
AS2
RGDP
Decrease in AS
[caused by “REP”]
Decrease in AS [“REP”]
Resource Cost [domestic]
AD
AS3
AS1
a. Land, labor, & capital
become more scarce
b. Hiring more union workers
c. Number of sellers decrease
PL
Resource Cost [overseas]
c. Imported input prices increase
d. Dollar depreciates
Environment [legal-institutional]
a. Decrease in subsidies
b. Increase in bus. regulations
c. *Increase in business taxes
Productivity
Decrease in productivity
RGDP
2
2
2
2
[“REP”]
D
___33.
Decrease in the availability of key natural resources (R)?
C
___34.
Increase in resource productivity (P)?
A
___35.
Increase in foreign spending on our products (Xn)?
B
___36.
Substantial reduction in government spending (G)?
C
___37.
Declines in the prices of imported resources (R)?
B
___38.
Declines in the incomes of our trading partners (Xn)?
A
___39.
Improvement in business profit expectations (Ig)?
B
___40.
Stock market plunge affects consumer wealth (C)?
B
___41.
There is an increase in interest rates [stable prices] (C & Ig)?
A
___42.
Consumer indebtedness is very low (C)?
Extra:
D
___43.
Increased government regulations are forced on businesses (E)?
C
___44.
The government increases subsidies to all farmers (E)?
Points of Emphasis for AD/AS Questions
1. Wages (labor), this is resource cost, so AS shifter.
2. Increase/decrease in union workers hired –
they get paid more – so labor, so AS shifter.
3. Appreciation/depreciation of a currency [either AD or AS]
a. Resource cost is part of REP, so it is AS shifter.
b. Exports are part of C+Ig+G+Xn, so it is AD shifter.
4. Regulations and subsidies [legal-institutional
Environment], part of REP, so they are AS shifters.
5. For all C+Ig+G+Xn, does the situation result in
an increase or decrease in AD & therefore GDP?
6. For REP, think of production costs –
if producers make more money, there is an increase in AS,
if producers make less money – there is a decrease in AS.