Transcript Document

Chapter 10
Real GDP and
the Price Level
in the Long Run
Chapter Overview
• Aggregate Demand (AD)
• Long Run Aggregate Supply (LRAS)
• Long Run Equilibrium
 Price Level
 Real GDP
• Inflation / Deflation
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10-2
Aggregates
• What is an economic aggregate?
 An abstraction
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10-3
Output Growth and the Long-Run
Aggregate Supply Curve
• Aggregate Supply
 The total of all planned production for
the economy
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10-4
Output Growth and the Long-Run
Aggregate Supply Curve (cont'd)
• Long-Run Aggregate Supply Curve
 A vertical line representing the real output
of goods and services after full adjustment
has occurred
 It represents the real GDP of the economy
under conditions of full employment;
the economy is on its production
possibilities curve
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10-5
Figure 10-1 The Production Possibilities
and the Economy’s Long-Run Aggregate
Supply Curve
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10-6
Output Growth and the Long-Run
Aggregate Supply Curve (cont'd)
• Growth is shown by outward shifts of either
the production possibilities curve or the LRAS
curve caused by
 Growth of population
 Growth in labor-force participation rate
 Capital accumulation
 Improvements in technology
 Increase in resource base
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10-7
Figure 10-2 The Long-Run Aggregate
Supply Curve and Shifts in It
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10-8
Total Expenditures
and Aggregate Demand
• Aggregate Demand
 The total of all planned expenditures in the
entire economy
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10-9
Total Expenditures
and Aggregate Demand (cont'd)
• Questions
 What determines the total amount that
individuals, governments, firms, and
foreigners want to spend?
 What determines the equilibrium
price level?
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10-10
The Aggregate Demand Curve
• Aggregate Demand Curve
 A curve showing planned purchase rates
for all final goods and services in the
economy at various price levels, all other
things held constant
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10-11
Figure 10-4
The Aggregate Demand Curve
As the price
level rises, real
GDP declines
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10-12
The Aggregate Demand
Curve (cont'd)
• What happens when the price
level changes?
 The real-balance effect (or wealth effect)
 The interest rate effect
 The open economy effect
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10-13
The Aggregate Demand
Curve (cont'd)
• The Real-Balance Effect
(The Wealth Effect)
 Purchasing Power of cash balances
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10-14
The Aggregate Demand
Curve (cont'd)
• The Interest Rate Effect
 Lower price levels indirectly decrease the
interest rate, which in turn causes an increase
in borrowing and spending.
 ↓ Price level  ↓ demand for loans  ↓ i-rate
 ↓ Price Level  ↓ i-rate  ↑ Investment
↑ Consumption
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10-15
The Aggregate Demand
Curve (cont'd)
• The Open Economy Effect
 Higher price levels result in foreigners’
desiring to buy fewer American-made
goods while Americans desire more
foreign-made goods (i.e., net exports fall).
 ↑ P-level  ↓ goods purchased
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10-16
Aggregate Demand versus
Demand for a Single Good
• When the aggregate demand curve is
derived, we are looking at the entire
circular flow of income and product.
• When a demand curve is derived, we
are looking at a single product in one
market only.
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10-17
Shifts in the Aggregate
Demand Curve
• Any non-price-level change that
increases aggregate spending (on
domestic goods) shifts AD to the right.
• Any non-price-level change that
decreases aggregate spending (on
domestic goods) shifts AD to the left.
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10-18
Shifts in the Aggregate
Demand Curve
GDP Deflator
Increase in aggregate demand
120
90
AD
0
1
2
3
4
5
Real GDP per Year
($ trillions)
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6
AD1
7
10-19
Shifts in the Aggregate
Demand Curve (cont'd)
GDP Deflator
Decrease in aggregate demand
120
100
0
9
10
11
12
AD1
AD
13
14
Real GDP per Year
($ trillions)
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15
10-20
Non Price Determinants of
Aggregate Demand (AD)
• Government Spending Fiscal Policy
• Tax Policy
• Expectations
• Money Supply
Monetary Policy
• Population
• Foreign exchange rate
• Economic Conditions in other countries
• Interest Rate
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10-21
Long-Run Equilibrium
and the Price Level
• For the economy as a whole, long-run
equilibrium occurs at the price level
where the aggregate demand curve
(AD) crosses the long-run aggregate
supply curve (LRAS).
• Equilibrium = Stability
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10-22
Figure 10-5 Long-Run
Economywide Equilibrium
Equilibrium
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10-23
Long-Run Equilibrium
and the Price Level (cont'd)
• The effects of economic growth on the
price level
 Economic growth and secular deflation
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10-24
Long-Run Equilibrium
and the Price Level (cont'd)
• Secular Deflation
 A persistent decline in prices resulting from
economic growth in the presence of stable
aggregate demand
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10-25
Secular Deflation versus Long-Run
Price Stability in a Growing Economy
• Secular deflation
 An increase in LRAS will, ceteris paribus, result in
a decrease in the price level.
• Avoiding secular deflation
 If the AD curve shifts outward by the same
amount as the LRAS curve, the price level
remains constant.

The AD curve can be shifted outward by increasing the
money supply.
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10-26
Figure 10-6 Secular Deflation versus
Long-Run Price Stability in a Growing
Economy, Panel (a)
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10-27
Figure 10-6 Secular Deflation versus
Long-Run Price Stability in a Growing
Economy, Panel (b)
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10-28
International Example:
Deflation is the Norm in Japan
• Since 1998, Japan’s real GDP has
increased every year except 2002.
• As the LRAS curve shifted rightward,
the price level gradually declined.
• Consequently Japan experienced
deflation.
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10-29
Secular Inflation
• A persistent rise in prices resulting from
Aggregate Demand (AD) increasing
faster that aggregate supply
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10-30
Supply Side Inflation
• When LRAS1 shifts to
LRAS2, the price level
rises from 120 to 140
• Inflation is caused by
a decrease in LRAS
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10-31
Demand Side Inflation
An increase in AD from AD1
to AD2 causes the price
level to rise from 120 to 140,
and an increase in AD
causes inflation
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10-32
Figure 10-7 Inflation Rates
in the United States
Source: Economic Report of the President; Economic Indicators, various issues
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10-33