Transcript Aggregate Spending

Principles of Economics:
Macroeconomics - Econ101
Aggregate Demand
Chapter 9
McGraw-Hill/Irwin
Copyright © 2010 by the McGraw-Hill Companies, Inc. All rights reserved.
Aggregate Demand
• Aggregate demand: The total
quantity of output (real GDP)
demanded at alternative price
levels in a given time period,
ceteris paribus
• The aggregate demand curve
illustrates how the real value
of purchases varies with the
average level of prices
• The downward slope suggests
that with a given (constant)
income, at lower price levels
people will buy more goods
and services
9-2
Three Reasons for the Downward Slope
Wealth Effect:
The change in the purchasing
power of dollar-denominated
assets that results from a
change in the price level.
International Trade Effect:
The change in foreign sector
spending as the price level
changes.
Interest Rate Effect:
Changes in household
and business buying as
the interest rate changes.
9-3
Components of Aggregate Demand
• The four components of aggregate demand are
–
–
–
–
Consumption (C)
Investment (I)
Government spending (G)
Net exports (X – M)
9-4
Determinants of AD on (C)
1. Wealth - The value of all assets owned, both
monetary and non- monetary
Wealth ↑ → C ↑ → AD ↑
Wealth ↓ → C ↓ → AD ↓
2. Expected Future Prices
Expect higher future prices → C↑ → AD↑
Expect lower future prices → C↓ → AD↓
9-5
Determinants of AD on (C)
3. Expected Future Income
Expect higher future income → C ↑ →A D↑
Expect lower future income → C↓ → AD↓
4. Interest Rates
Interest Rate ↑ → C↓ → AD↓
Interest Rate ↓ → C ↑ → AD↑
5. Income Taxes
Income taxes ↑ → C↓ → AD↓
Income taxes ↓ → C ↑ → AD↑
9-6
Determinants of AD on (I)
1. Interest Rates
Interest rates ↓ → I ↑ → AD↑
Interest rates ↑ → I↓ → AD↓
2. Expected Future Sales
Optimistic about future sales → I ↑ → AD↑
Pessimistic about future sales → I↓ → AD↓
3. Business Taxes
Business taxes↓ → I↑ → AD↑
Business taxes↑ → I↓ → AD↓
9-7
Determinants of AD on (NE)
1. Foreign Income
Foreign real national income ↑ → EX↑ → NX↑ →AD↑
Foreign real national income ↓ → EX↓ → NX↓ →AD↓
2. Exchange Rates
US $ depreciates → EX↑ and IM ↓ → NX↑ →AD↑
US $ appreciates → EX↓ and IM ↑ → NX↓ →AD↓
9-8
Aggregate Supply
• Aggregate supply: The
total quantity of output
(real GDP) producers
are willing and able to
supply at alternative
price levels in a given
time period, ceteris
paribus
• Two reasons for upward
sloping curve:
– The profit effect
– The cost effect
9-9
….because over the short-run, as the price level increases, the
quantity of goods and services firms are willing to supply will
increase.
As prices of final goods & services rise, prices of inputs, such as
the wages of workers or the price of a natural resources, rise
more slowly. Profits rise when the prices of the goods &
services firms sell rise more rapidly than the prices they pay for
inputs.
9-10
 Wage rates
 Productivity
 Supply shocks
 Adverse
 Beneficial
9-11
Macro Equilibrium
•
Aggregate supply and
demand curves summarize
the market activity of the
whole (macro) economy
Aggregate
supply
P
1
Equilibrium (macro): The
combination of price level
PE
and real output that is
compatible with both
aggregate demand and
aggregate supply
E
Macro equilibrium
PRICE LEVEL
•
Aggregate
demand
D1
QE
S1
REAL OUTPUT
9-12
Competing Theories of Short-Run
Instability
• Macro controversies focus on the shape of
aggregate supply and demand curves and the
potential to shift them
• Demand-side theories, such as Keynesian and
Monetary, emphasize aggregate-demand shifts
• Supply-side theories center on shifts in supply
9-13
Keynesian Theory
• Keynes argued that a deficiency of spending
tends to depress an economy and cause
persistently high unemployment
• Advocated increasing government spending –
a rightward AD shift – to move the economy
toward full employment
9-14
Monetary Theories
• Monetary Theories emphasize the role of
money in financing aggregate demand
• Money and credit affect ability and willingness
to buy goods and services
• If credit isn’t available or is too expensive
consumers reduce spending and businesses
curtail investment
9-15
Supply-Side Theories
• Inadequate supply can keep the economy
below its full-employment potential and cause
prices to rise as well
• Increases in aggregate supply move us closer
to goals of price stability and full employment
9-16
Long-Run Self Adjustment
• Some economists argue that the long-run trend
of the economy is what really matters, not
short-run fluctuations
• They assert a long-run aggregate supply curve
anchored at the natural rate of output (QN)
– Flexible prices (and wages) enable the economy to
maintain the natural rate of output QN
9-17
The “Natural” Rate of Output
PRICE LEVEL
AS
P2
P1
AD2
AD1
QN
REAL OUTPUT
Fluctuations in aggregate demand affect the price level but not real output.
9-18
Short vs. Long-run Perspectives
• The long-run aggregate supply curve is likely
to be vertical at QN
• The short-run aggregate supply curve is likely
to be upward-sloping
• Both aggregate supply and aggregate demand
influence short-run macro outcomes
9-19
Policy Strategies
• Shift the aggregate demand curve: Use policy
tools that affect total spending
• Shift the aggregate supply curve: Implement
policy levers that influence the costs of
production or otherwise affect output
• Laissez-faire: Don’t interfere with the market;
let markets self adjust
9-20
Selecting Policy Tools
• There are a host of tools available:
–
–
–
–
–
Classical laissez faire
Fiscal policy
Monetary policy
Supply-side policy
Trade policy
9-21
Policy Tools
• The laissez-faire approach requires no tools,
as the economy naturally self-adjusts to full
employment
• Fiscal policy: The use of government taxes
and spending to alter macroeconomic
outcomes
9-22
Policy Tools
• Monetary policy: The use of money and
credit controls to influence macroeconomic
outcomes
• Supply-side policy: The use of tax incentives,
(de)regulation, and other mechanisms to
increase the ability and willingness to produce
goods and services
9-23
Policy Tools
• Trade policy can be used to affect
international trade and money flows and shift
the aggregate demand and/or the aggregate
supply curve
9-24