Parkin-Bade Chapter 22
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Transcript Parkin-Bade Chapter 22
Ch. 10: Aggregate Supply and Demand
Derive AS/AD model
Understand cause & consequences of change in AS/AD
• Short run vs Long run
• Effects on economic growth, prices, unemployment.
Different schools of thought in macroeconomics
Macroeconomic Long Run and Short Run
The Macroeconomic LR
a time frame that is sufficiently long for the real wage rate
to have adjusted to achieve full employment:
Real GDP = potential GDP.
Unemployment=natural unemployment rate.
Price level determined by quantity of money (equation of exchange)
Inflation rate =money growth rate minus the real GDP growth rate.
The Macroeconomic SR
a period during which some prices are sticky so
Real GDP might be below, above, or at potential GDP.
The unemployment rate might be above, below, or at the natural
unemployment rate
Aggregate Supply
The quantity of real GDP supplied is the total quantity
that firms plan to produce during a given period. It depends
on
The quantity of the labor employed
The quantity of physical and human capital
State of technology
Two time frames associated with different states of the
labor market:
Long-run aggregate supply
Short-run
aggregate supply
Aggregate Supply
Long-Run Aggregate Supply (LAS)
the relationship between the quantity of real GDP
supplied and the price level when real GDP equals
potential GDP.
Potential GDP is determined by
•Production function
•Labor market
•Independent of price level
LR aggregate supply curve (LAS) is vertical at potential
GDP.
Determinants of LAS
Labor market
Production function
LAS
Determinants of LAS
Change in labor supply
• immigration
• taxes on employees
• transfers (UI, SS)
• population growth
• retirement
Change in labor demand
• worker productivity (also affects PF)
• taxes on employer payroll
Shifts in Production Function
• capital/technology (also affects LD)
• human capital
Graphic analysis of changes in LAS
(Change in Labor Supply)
Effect on
•Real wage
•Employment
•productivity
Graphic analysis of changes in LAS
(change in Labor Demand)
Effect on
•Real wage
•Employment
•Productivity
Graphic analysis of changes in LAS
(Change in Production Function)
Effect on
•Real wage
•Employment
•productivity
Aggregate Supply
Short-Run Aggregate Supply (SAS)
the relationship between real GDP supplied and the price
level when the money wage rate, the prices of other
resources, and potential GDP remain constant.
A rise in the price level with no change in the money
wage rate and other factor prices increases the quantity of
real GDP supplied.
• as P rises, real wage declines, firms want to hire
more employees (movement along labor demand
curve)
The short-run aggregate supply curve (SAS) is upward
sloping.
Short Run Aggregate Supply
Labor market
SAS
Production function
Aggregate Supply
Along the SAS
curve, real GDP
supplied might be
above potential
GDP…
or below potential
GDP.
Aggregate Supply
Changes in Aggregate Supply
When potential GDP increases, both the LAS and SAS
curves shift rightward.
Potential GDP changes, for three reasons:
The full-employment quantity of labor changes
The quantity of capital (physical or human) changes
Technology advances
Aggregate Supply
An increase in
potential GDP shifts
the LAS curve and the
SAS curve shifts along
with the LAS curve.
Aggregate Supply
A rise in the money
wage rate
Decreases short-run
aggregate supply and
shifts the SAS curve
leftward.
Has no effect on longrun aggregate supply.
In the short run, if the economy moves
upward along the SAS curve, prices are
____, real wages are _____ and real GDP
is _____.
1. Falling; rising; falling.
2. Falling; rising; rising.
3. Rises; rising; rising.
4. Rising; falling; rising.
Aggregate Demand
AD is the total amount of final goods and services
produced in the United States that people, businesses,
governments, and foreigners plan to buy.
AD= C + I + G + (X – M.)
AD depends on
The price level
Expectations about future
Changes in wealth
Fiscal policy and monetary policy
The world economy
Aggregate Demand
The Aggregate Demand
Curve
plots the quantity of real
GDP demanded against P.
slopes downward for 2
reasons:
Wealth effect
Substitution effects
Aggregate Demand
Wealth Effect
P increases
real wealth decr C decr AD decr
Substitution Effects
•Intertemporal
P incr
int rate incr C & I decr AD decr
• International
P incr
imports incr, exports decr AD decr
Shifts in Aggregate Demand
Expectations about future
• Increases in expected future income
increases C today
increases AD.
• Increase in expected future inflation
buying goods cheaper today
increases AD.
• Increase in expected future profits
investment
increases AD
Shifts in Aggregate Demand
Fiscal Policy
setting and changing taxes, transfer payments, and
purchasing goods and services.
An income tax cut or increase in transfers
increases disposable income (income-taxes+
transfers)
increases C
increases AD
An increase in government spending
increases G
increases AD
Shifts in Aggregate Demand
Monetary policy
changes in interest rates and the quantity of money in the
economy.
An increase in the money supply reduces interest rates
and increases aggregate demand.
Shifts in Aggregate Demand
Summary:
Fiscal policy
Monetary policy
Value of $
Foreign income
Macroeconomic Equilibrium
SR Equilibrium:
SAS=AD
GDP can be above, below, or at potential GDP
LR equilibrium
LAS=SAS=AD
Macroeconomic Equilibrium
Graphical illustration of SR equilibria with
1. GDP>potential GDP (inflationary gap)
2. GDP<potential GDP (recessionary gap)
3. GDP=potential GDP (LR equilibrium)
•Transition from GDP>potential GDP to LR equilibrium
(inflationary gap)
•Initially:
• empl > equil. Empl
• unempl < natural rate
• R-wage < equil. R-wage
• upward pressure on R-waqes
• SAS shifts left until GDP=potential GDP
•As economy moves to LR Equilibrium:
Employment falls, Unemployment rises,
Real wage rises, Real GDP falls
•Transition from GDP<potential GDP to LR equilibrium
(recessionary gap)
•Initially:
• empl < equil. Empl
• unempl > natural rate
• R-wage > equil. R-wage
• downward pressure on R-waqes
• SAS shifts left until GDP=potential GDP
•As economy moves to LR Equilibrium:
Employment rises
Unemployment falls
Real wage falls
Real GDP rises
SR/LR effect of changes in AD
Effect of Increase in AD on real wage, prices, real GDP
unemployment and employment.