Transcript Document

National Income and Price
Determination
Unit Goals: The student will be able to . . .
•
Understand three keys facts about economic fluctuations
•
Identify the determinants of aggregate demand and aggregate
supply.
•
Use the aggregate expenditure and the AD/AS models to
analyze the economy and determine real output and price
level.
•
Use the concept of the multiplier effect.
•
Explain the shortcomings of the AD/AS model including sticky
wages and prices.
Unit Three: National Income + Price Determination
• Aggregate demand
• Determinants of aggregate demand
• Multiplier and crowding-out effects
• Aggregate supply
• Short-run and long-run analyses
• Sticky versus flexible wages and prices
• Determinants of aggregate supply
• Macroeconomic equilibrium
• Real output and price level
• Short and long run
• Actual versus full-employment output
• Business cycle and economic fluctuations
Three Keys Facts about Economic Fluctuations
1
ECONOMIC FLUCTUATIONS ARE IRREGULAR
AND UNPREDICTABLE
Fluctuations often called business cycle (periods
of expansions and contractions)
Three Keys Facts about Economic Fluctuations
2FLUCTUATE
MOST MACROECONOMIC QUANTITIES
TOGETHER
•
•
Real GDP monitors short-run changes in the economy
When real GDP falls in a recession, so do
• Personal income
• Corporate profits
• Consumer spending
• Investment spending
• Industrial production
• Retail sales
• Home sales
• Auto sales
•Three Keys Facts about Economic Fluctuations
3 AS OUTPUT FALLS, UNEMPLOYMENT RISES
Changes in an economy’s output of goods and
services are correlated with changes in the
economy’s utilization of its labor force
Decrease in production = decrease in workers
needed
The Basic Model of Economic Fluctuations
Focuses on the behavior of TWO variables
1. Economy’s output of goods and services as measured by
real GDP
2. The overall price level as measured by the CPI
Model of aggregate demand and aggregate supply: Used to
explain short-run fluctuations in economic activity around its
long-run trend
Vertical axis – overall price level in the economy
Horizontal axis – overall quantity of goods and services
Aggregate Demand (AD) Curve
Shows us the quantity of all goods and services that
households, firms, and the government want to buy
at any given price level
Aggregate Demand Curve
• Downward
sloping
• Inverse
relationship between the quantity of real
output demanded and the price level
Lower price level = greater amount of output
demanded
Higher price level = decreased amount of output
demanded
Aggregate Demand
GDP is the sum of C + I + G + (X-M)
1. Consumption – spending by domestic households
on goods and services
2. Investment – spending by firms on capital
equipment and by households on real estate or
homes
3. Government spending – spending by governments
on goods and services
4. Net Exports – exports minus imports
Measures
GDP
The Aggregate Demand Curve
Downward sloping curve inversely related to the average price
level
P = Average price level
Y = Real National Output Levels (rGDP)
ASSUME that government
spending is fixed by policy
The other three components of
spending (consumption, investment,
and net exports) depend on
-
Movement along the AD curve
•A
change in the price level
of a nation’s output will
lead to a movement along
the AD curve and a change
in the quantity of national
output demanded.
Three reasons for the inverse relationship
between the average price level (PL) and real
national output (rGDP)
1.
Wealth Effect
1.
Interest-Rate Effect
2.
Exchange-Rate Effect
The Price Level and Consumption:
The Wealth Effect
Higher price levels reduce the
purchasing power or the real
value of the household’s
wealth and savings
The public feels poorer with
higher price levels so they
demand a lower quantity of
the nation’s output.
The Wealth Effect
Lower price levels mean that
your dollars become more
valuable because you can buy
more goods and services.
Decrease in price levels makes
consumers wealthier which
encourages them to spend
more.
The Price Level and Investment:
The Interest-Rate Effect
Higher price levels will cause
banks to raise the interest rates
on loans.
At high interest rates, the
quantity demanded of products
and capital for which households
and firms must borrow
decreases.
The Interest-Rate Effect
Lower price levels cause
households to invest in
interest-bearing savings
accounts or bonds.
Banks will use this extra cashflow to lower interest rates
for other borrowers.
The Price Level and the Foreign Market:
The Net-Export Effect
Higher price levels cause
goods and services
produced in a given country
to become less attractive to
foreign consumers and
imports to become more
attractive to domestic
consumers.
•The Net-Export Effect
Lower price levels in U.S.
increase the amount of U.S.
goods and services
demanded from abroad and
decreases the domestic
demand for imports.
Question of the Day 11.28/11.29
When price levels in Japan decrease
A.
B.
C.
D.
Japan will sell more exports and purchase
more imports.
Japan will sell less exports and purchase
more imports.
Japan will sell less exports and purchase
less imports.
Japan will sell more exports and purchase
less imports.
Quick Summary
•
Three distinct but related reasons why a fall in CPI increases rGDP
•
•
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1. Consumers are wealthier which stimulates the
demand for consumption goods
2. Interest rates fall which stimulates the demand for
investment goods.
3. The exchange rate depreciates which stimulates the
demand for net exports.
•
These 3 are the reasons why the aggregate demand curve slopes
downward, ceteris paribus.
•
Assumes that the money supply is fixed.
Shifts in the AD curve
To the right . . .
If C, I, G, or Net Exports
increase
To the left . . .
If C, I, G, or Net Exports
decrease
Shifts arising from consumption
To the left –
Americans become more preoccupied with saving rather
than spending (AD decreases at every PL)
Increasing taxes discourages spending (AD decreases at
every PL)
To the right –
Stock market boom makes people wealthier and less
concerned about saving (AD increases at every PL)
Cutting taxes encourages spending (AD increases at every
PL)
Shifts Arising from Investment
To the left –
Firms are pessimistic about business conditions (AD will decrease at every PL)
Repeal of an investment tax credit (AD will decrease at every PL)
Decrease in money supply increases interest rate (AD will decrease at every PL)
To the right –
Computer company introduces the first touch screen and other companies
want to catch up (AD will increase at every PL)
Investment tax credit (AD will increase at every PL)
Increase in money supply lowers interest rate (AD will increase at every PL)
Shift arising from Government Purchases
The most direct way that policy makers shift the AD curve is through
government purchases.
To the left –
Congress decides to spend less on the military (AD will decrease at every
level)
State governments cut education spending (AD will decrease at every
PL)
To the right –
Congress decides to purchase new weapons systems. (AD will increase
at every PL)
State governments build more highways (AD will increase at every PL)
Shifts arising from Net Exports
To the left –
Europe experiences a recession (AD will decrease at every PL)
Appreciation of U.S.D. (AD will decrease at every PL)
To the right –
Europe recovers from a recession (AD will increase at every PL)
Depreciation of U.S.D. (AD will increase at every PL)
Quick Review
The three facts about economic fluctuation
The three reasons that the AD curve is downward sloping
The reasons why the AD curve might shift to the left or to the
right
HW: Complete quick quiz on p. 733
The Aggregate-Supply Curve
Illustrates the total quantity of goods and services that firms
produce and sell at any given price level.
Unlike the AD curve (which is always
downward sloping), the AS curve depends
on the time period under examination
Short-Run VS. Long-Run AD
Short-run AD – upward sloping
Long-run AD – vertical
Long-run AS
In the long run, an economy’s production of goods and services
(real GDP) depends on its supplies of land, labor, capital, and
technology used to turn these factors of production into goods and
services.
PL does not affect these long-run determinants of real GDP.
The resources, not price, determine the total quantity of goods and
services supplied.
LONG-RUN AS
Based on classical macroeconomic theory that real variables
(real GDP) do not depend on nominal variables (level of prices)
This works out over a period of years.
****Curve is vertical at natural rate of
output*****
WHY LONG-RUN AS MIGHT SHIFT
Natural rate of output because it shows when