Transcript Fina 353-Lecture Slide Week 7

ECON203
Principles of Macroeconomics
Week 7
Topic: Aggregate Demand
Dr. Mazharul Islam
1
Learning outcomes for
student revision
To learn about
After studying these topics you should be able to:
 Understand the meaning and factors that affect
Aggregate Demand.
 Show changes using an AD and explain their output
and price implications
 Explain the meaning and differences between
Equilibrium output (Ye) and Potential output (YP) and
why and how they will change
Dr. Mazharul Islam
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Aggregate Demand
• Aggregate Demand:It is the relationship
between the quantity of real GDP demanded
and the price level when other influences on
expenditure plans remain the same.
• This relationship as follows:
• Other things remaining the same, the higher the
price level , the smaller is the quantity of real
GDP demanded; and the lower the price level,
the greater is the quantity of real GDP
demanded .
Dr. Mazharul Islam
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Aggregate Demand
Fundamentals
 The quantity of real GDP demanded (Y) is the total
amount of final goods and services produced in
Saudi Arabia that people, businesses, governments,
and foreigners plan to buy.
 This quantity is the sum of planned:
o consumption expenditures (C),
o investment (I),
o government spending (G), and
o exports minus imports (net exports), (X – M).
That is: Y = C + I + G + (X – M) = GDP
(expenditure measure)
Dr. Mazharul Islam
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Aggregate Demand Curve
Dr. Mazharul Islam
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Aggregate Demand Curve Downward slope.
“the higher (lower) the price level the smaller (greater) the
quantity of real GDP demanded” when other things are
constant. Because a change in the price level brings a
change in: 1.The buying power of money 2. The real
interest rate 3. The real prices of exports and imports
The buying power of money (Wealth Effect)
A rise in the price level lowers the buying power of
money. That means the same quantity of money can not
buy the same quantity of goods and services as price level
Drops
increases. As prices rise the buying power of your wealth ________
Decrease
and the quantity of Saudi Arabia’s real GDP demanded ________
Dr. Mazharul Islam
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Aggregate Demand Curve Downward slope
•When the price level ( )demand for money (the
amount of money that people want to hold) ( ),
the nominal interest rate ( )the real interest rate
( ).
• Faced with higher real interest rate, businesses
and people delay plans to buy new capital and
consumer durable goods and they will decrease
spending.
Increase and the
As prices rise the interest rate ________
quantity of Saudi Arabia’s real GDP demanded
Dr. Mazharul Islam
Decrease .
________
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Aggregate Demand Curve Downward slope
The Real Prices of Exports & Imports (Substitute Effects)
When the country's price level increases and the prices in
other countries do not change
local made goods and services will be more
expensive than the foreign made items.
People will spend less on local made items and that
means a decrease in real GDP demanded.
Less and
As prices rise export buyers will tend to buy________
More imports, so the quantity of
Saudi People will buy ______
KSA’s real GDP demanded _________
Decrease
Dr. Mazharul Islam
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Aggregate Demand Curve Downward slope
Price Level
Price level ↑ moves
us leftward along
the AD curve
P3
Price level ↓ moves
us rightward along
the AD curve
P1
P2
AD
Q3
Q1
Q2
Real GDP
Dr. Mazharul Islam
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Changes in Aggregate Demand.
•A change in any factor other than the price
level brings a change in aggregate demand and
aggregate demand curve shifts to the right
(aggregate demand increases)or to the
left(aggregate demand decreases) .
•The factors are :
1. Expectations about
the future (concerning
economic, political and social factors)
2. Government Economic Policies (Fiscal and
monetary policies)
3. The state of the world economy (net exports)
Dr. Mazharul Islam
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Changes in AD (Shift of the
AD curve) for expectation
With same price level
1)
2)
3)
4)
5)
6)
Expected higher future income-AD
Expected lower future income-AD
Expected higher future inflation-AD
Expected lower future inflation-AD
Expected higher future profits-AD
Expected lower future profits-AD
(Rightward)
(Leftward)
(Rightward)
(Leftward)
(Rightward)
(Leftward)
Dr. Mazharul Islam
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Changes in AD (Shift of the
AD curve) for government policies
With same price level
1) Expansionary fiscal policy (tax ,G ,TP )-AD
(Rightward)
2) Contractionary fiscal policy (tax ,G ,TP )-AD
(Leftward)
3) Expansionary monetary policy (i MS ) -AD
(Rightward)
4) Contractionary monetary policy(i MS )-AD
(Leftward)
Dr. Mazharul Islam
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Changes in AD (Shift of the AD
curve) for state of the world economy
With same price level
1) Better world economy (foreign income )-AD
(Rightward)
2) Worse world economy (foreign income )-AD
(Leftward)
3) Lower exchange rate (X M ) -AD
(Leftward)
4) Higher exchange rate (X M ) -AD
(Rightward)
Dr. Mazharul Islam
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Changes in AD (Shift of the
AD curve)
Price
Level
Entire AD curve shifts rightward if:
• a, I, TP, G, or NX increases
• Net taxes, i decrease
• The money supply increases
Price
Level
Entire AD curve shifts leftward if:
• a, I, TP, G, or NX decreases
• Net taxes, i increase
• The money supply decrease
AD2
AD1
AD1
Real GDP
Dr. Mazharul Islam
AD2
Real GDP
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Macroeconomic Equilibrium
(short-run)
 Occurs when the quantity of real GDP
demanded equals the quantity of real GDP
supplied at the point of intersection of the AD
curve and the SAS curve.
i.e. AD = SAS shows where the economy is NOW
 Only at this combination of prices and
production can firms sell all their output and
people buy all the goods and services they
demand.
 Short-run equilibrium is the normal state of the
economy as it fluctuates around potential GDP.
Dr. Mazharul Islam
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Short-Run Equilibrium – Graph
Price
Level
125
SAS
115
Short-run
macroeconomic
equilibrium
105
95
85
AD
0
860
880
900
920
940
Real GDP
Dr. Mazharul Islam
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Explaining Macroeconomic
Fluctuations
– Figure 10.6 illustrates a
short-run equilibrium.
– If real GDP is below
equilibrium GDP, firms
increase
production
and raise prices…
– … and if real GDP is
above equilibrium GDP,
firms
decrease
production and lower
prices.
Dr. Mazharul Islam
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What Happens When Things
Change?
 Our short-run equilibrium will change when either
AD curve, SAS curve, or both, shift
 An event that causes AD curve to shift is called a
demand shock.
 An event that causes AS curve to shift is called a
supply shock.
 A change in spending by one or more sectors
that ultimately affects entire economy
 Demand shocks and supply shocks are just two
different categories of spending shocks
Dr. Mazharul Islam
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The Effect of a Demand Shock
in short-run
SAS
Price Level
130
115
100
H
J
E
AD1
10
13.5
12.5
AD2
Real GDP($ Trillions)
Dr. Mazharul Islam
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An Increase in Government Purchases
An Increase in Money Supply
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Inflationary and Recessionary
Gap
– The amount by which real GDP exceeds potential
GDP is called a inflationary gap.
– The amount by which real GDP is less than
potential GDP is called a recessionary gap.
Dr. Mazharul Islam
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Thinking time…………………..
Question 1: Home Work Question (4 marks)
Using the AD/AS model, show and explain (using four
separate diagrams) the likely impact of the following events
on KSA’s prices and output. Consider the economy initially
at full employment.
i. Consumer confidence strengthens
ii. The world experiences a strong resources price boom.
iii. Oil prices fall substantially
iv. There’s a significant technological development and
improvement.
Dr. Mazharul Islam
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Thinking time…………………..
Question 2: Home Work Question (4 marks)
Draw on an AD/AS graph the expected impacts of the
following factors and explain the effects on the economy.
(a) A falling stock market
(b) Increasing labour market participation
Dr. Mazharul Islam
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Now it’s over for
today. Do you have
any question?
Dr. Mazharul Islam
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