Transcript AD/AS - PBworks

Why is this good?
• Breaking News Alert
The New York Times
Tuesday, March 13, 2012 -- 4:08 PM EDT
----Stocks Rally Strongly, With Nasdaq Above 3,000
Stocks climbed to new heights in part on rosy retail sales data on Tuesday,
pushing the broad market to levels last seen in June 2008 and the Nasdaq
composite index past the 3,000 milestone for the first time since 2000.
Read More:
http://www.nytimes.com/?emc=na
AD/AS
What causes short run changes in the
business cycle?
The Model of Aggregate Demand and
Aggregate Supply
• Economist use the model of aggregate
demand and aggregate supply to explain
short-run fluctuations in economic activity
around its long-run trend.
Economic
activity
Business
cycle
Time
http://www.youtube.com/watch?v=hTWPrWmPJS0
The Model of Aggregate Demand and
Aggregate Supply
• The aggregate-demand curve shows the
quantity of goods and services that
households, firms, and the government want
to buy at each price level.
• The aggregate-supply curve shows the
quantity of goods and services that firms
choose to produce and sell at each price level.
Sum each definition in six words or
less!!!
Figure 2 Aggregate Demand and
Aggregate Supply...
Price
Level
How do we
measure price
level?
Aggregate
supply
Equilibrium
price level
PPI
CPI
Price
Deflator
Aggregate
demand
0
Equilibrium
output
Quantity of
Output
Figure 3 The Aggregate-Demand
Curve...
Price
Level
P
WHY???
P2
1. A decrease
in the price
level . . .
Aggregate
demand
0
Y
Y2
2. . . . increases the quantity of
goods and services demanded.
Quantity of
Output
Why the Aggregate-Demand Curve Is
Downward Sloping
• The Price Level and Consumption:
– The Wealth Effect
• The Price Level and Investment:
– The Interest Rate Effect
• The Price Level and Net Exports:
– The Exchange-Rate Effect
Why the Aggregate-Demand Curve Is
Downward Sloping
• The Price Level and Consumption:
– The Wealth Effect
• A lower price level raises the real value of money and
makes consumers wealthier, which encourages them to
spend more.
• This increase in consumer spending means larger
quantities of goods and services demanded.
Why the Aggregate-Demand Curve Is
Downward Sloping
• The Price Level and Investment:
– The Interest Rate Effect
• A lower price level reduces the interest rate and makes
borrowing less expensive, which encourages greater
spending on investment goods.
• This increase in investment spending means a larger
quantity of goods and services demanded.
Why the Aggregate-Demand Curve Is
Downward Sloping
• The Price Level and Net Exports:
– The Exchange-Rate Effect
• A lower price level in the U.S. causes U.S. interest rates
to fall and the real exchange rate to depreciate, which
stimulates U.S. net exports.
• The increase in net export spending means a larger
quantity of goods and services demanded.
Aggregate Demand can either increase or decrease depending
on which variables shift the aggregate demand curve.
An increase in aggregate demand is always a shift to the right
A decrease in aggregate demand is always a shift to the left.
PL
Ad
Ad1
Ad1
Variables that influence the components-
C onsumption Relative prices of products/services
People’s preferences/tastes
Expectations of the future
Change in interest rates
Change in income
Variables that influence the components-
I nvestment Number of consumers
People’s preferences/tastes
Expectations of the future profit
Change in Inventories
Change in Interest rates
Change in income
Gross Private Domestic Business Investment
Variables that influence the components-
Government Spending
Dumb Politicians
Variables that influence the components-
(X - M) Relative quality of foreign goods/services
Exports Imports
Relative price of foreign goods/services
International value of the dollar
Interest rates
Variables that influence the components-
S avings
Relative prices of products/services
People’s preferences/tastes
Expectations of the future
Change in Interest rates
Change in income
Demand Shifts - Summary
1. Federal government increases personal income
tax rates
2. Federal Reserve implements “tight” monetary
policy
3. News media runs several stories showing
economy in positive light
4. U.S. currency exchange rate depreciates against
the Yuan (Chinese currency).
5. People increase savings rates
6. Construction of new housing increases
As
PL
Classical
Range
http://logic.csc.cuhk.edu.hk/~b024765/ricardo.jp
http://logic.csc.cuhk.edu.hk/~b024765/smith.jpg
g
.
http://logic.csc.cuhk.edu.hk/~b024765/say.jpg
COVER BY JOHN HELD JR
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http://www.nytimes.com/learning/general/onthisday/bday/0605.html
http://logic.csc.cuhk.edu.hk/~b024765/keynes.jpg
Intermediate Range
Keynesian Range
Full
Employment
Q = Real GDP = Y
As
PL
Structural
Frictional
Cyclical
Unemployment
Classical
Range
Intermediate Range
Keynesian Range
Full
Employment
Q = Real GDP = Y
THE AGGREGATE-SUPPLY CURVE
• In the long run, the aggregate-supply curve is
vertical because the price level does not affect
long run determinants of real GDP.
• In the short run, the aggregate-supply curve is
upward sloping.
THE AGGREGATE-SUPPLY CURVE
• In the long run, an economy’s production of
goods and services depends on its supplies of
labor, capital, and natural resources and on
the available technology used to turn these
factors of production into goods and services.
• The price level does not affect these variables
in the long run.
• The long-run aggregate supply represents the
classical dichotomy and money neutrality.
Figure 4 The Long-Run AggregateSupply Curve
Price
Level
Long-run
aggregate
supply
P
P2
2. . . . does not affect
the quantity of goods
and services supplied
in the long run.
1. A change
in the price
level . . .
0
Natural rate
of output
Quantity of
Output
Why the Long-Run Aggregate-Supply
Curve Might Shift
• Shifts might arise from changes in:
– Labor
– Capital
– Natural Resources
– Technological Knowledge
Figure 5 Long-Run Growth and
Inflation
2. . . . and growth in the
money supply shifts
aggregate demand . . .
Long-run
aggregate
supply,
LRAS 1980 LRAS
1990
LRAS
2000
Price
Level
1. In the long run,
technological
progress shifts
long-run aggregate
supply . . .
P 2000
4. . . . and
ongoing inflation.
P 1990
Aggregate
Demand, AD 2000
P 1980
AD 1990
AD 1980
0
Y 1980
Y 1990
Quantity of
Output
3. . . . leading to growth
in output . . .
Y 2000
Why the Aggregate-Supply Curve
Slopes Upward in the Short Run
• In the short run, an increase in the overall
level of prices in the economy tends to raise
the quantity of goods and services supplied.
• A decrease in the level of prices tends to
reduce the quantity of goods and services
supplied.
• As a result, the short-run aggregate-supply
curve is upward sloping.
Figure 6 The Short-Run AggregateSupply Curve
Price
Level
Short-run
aggregate
supply
P
P2
2. . . . reduces the quantity
of goods and services
supplied in the short run.
1. A decrease
in the price
level . . .
0
Y2
Y
Quantity of
Output
Why the Aggregate-Supply Curve
Slopes Upward in the Short Run
• Three Theories:
– The Sticky-Wage Theory
– The Sticky-Price Theory
– The Misperceptions Theory
Why the Aggregate-Supply Curve
Slopes Upward in the Short Run
• The Sticky-Wage Theory
– Nominal wages are slow to adjust to changing
economic conditions, or are “sticky” in the short
run
Why the Aggregate-Supply Curve
Slopes Upward in the Short Run
• The Sticky-Price Theory
– An unexpected fall in the price level leaves some
firms with higher-than-desired prices. For a
variety of reasons, they may not want to or be
able to change prices immediately.
Why the Aggregate-Supply Curve
Slopes Upward in the Short Run
• The Misperceptions Theory
– Changes in the overall price level temporarily
mislead suppliers about what is happening in the
markets in which they sell their output.
– A lower price level causes misperceptions about
relative prices.
– These misperceptions induce suppliers to
decrease the quantity of goods and services
supplied.
Why the Short-Run Aggregate-Supply
Curve Might Shift
• Shifts might arise from changes in:
– Expected Price Level.
– Labor.
– Capital.
– Natural Resources.
– Technology.
COSTS!!!!
Figure 7 The Long-Run Equilibrium
Price
Level
Long-run
aggregate
supply
Short-run
aggregate
supply
A
Equilibrium
price
Aggregate
demand
0
Natural rate
of output
Quantity of
Output
TWO CAUSES OF ECONOMIC
FLUCTUATIONS
• Four steps in the process of analyzing
economic fluctuations:
1. Determine whether the event affects aggregate
supply or aggregate demand.
2. Decide which direction the curve shifts.
3. Use a diagram to compare the initial and the
new equilibrium.
4. Keep track of the short and long run equilibrium,
and the transition between them.
Figure 8 A Contraction in Aggregate
Demand
2. . . . causes output to fall in the short run . . .
Price
Level
Long-run
aggregate
supply
Short-run aggregate
supply, AS
AS2
3. . . . but over
time, the short-run
aggregate-supply
curve shifts . . .
A
P
B
P2
P3
1. A decrease in
aggregate demand . . .
C
Aggregate
demand, AD
AD2
0
Y2
Y
4. . . . and output returns
to its natural rate.
Quantity of
Output
Figure 10 An Adverse Shift in
Aggregate Supply
1. An adverse shift in the shortrun aggregate-supply curve . . .
Price
Level
Long-run
aggregate
supply
AS2
Short-run
aggregate
supply, AS
B
P2
A
P
3. . . . and
the price
level to rise.
Aggregate demand
0
2. . . . causes output to fall . . .
Y2
Y
Quantity of
Output
The Effects of a Shift in Aggregate
Supply
• Adverse shifts in aggregate supply cause
stagflation—a period of recession and
inflation.
• Output falls and prices rise.
• Policymakers who can influence aggregate
demand cannot offset both of these adverse
effects simultaneously.
The Effects of a Shift in Aggregate
Supply
• Policy Responses to Recession
– Policymakers may respond to a recession in one of
the following ways:
• Do nothing and wait for prices and wages to adjust.
• Take action to increase aggregate demand by using
monetary and fiscal policy.
Figure 11 Accommodating an Adverse
Shift in Aggregate Supply
1. When short-run aggregate
supply falls . . .
Price
Level
Long-run
aggregate
supply
P3
C
P2
3. . . . which P
causes the
price level
to rise
further . . .
0
A
4. . . . but keeps output
at its natural rate.
Natural rate
of output
Short-run
aggregate
supply, AS
AS2
2. . . . policymakers can
accommodate the shift
by expanding aggregate
demand . . .
AD2
Aggregate demand,
AD
Quantity of
Output