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Unit 3-3:
Aggregate Demand and
Supply and Fiscal Policy
1
Shifters of Aggregate Demand
AD = C + I + G + X
Change in Consumer Spending
Change in Investment Spending
Change in Government Spending
Net EXport Spending
Shifters of Aggregate Supply
AS = R + A + P
Change in
Change in
Change in
Resource Prices
Actions of the Government
Productivity
2
Putting AD and AS together to get
Equilibrium Price Level and Output
3
Use the AD and AS model to show an
economy at full employment output
Price
Level
LRAS
AS
PLe
AD
QY
GDPR
4
#1. Assume there is an increase in consumer
spending. What happens to PL and output in the
short- run?
LRAS
Price
Level
AS
PL and Q will
Increase
PL1
PLe
AD
QY Q1
AD1
GDPR
5
Practice
AD or AS
Shifter
Increase or
Decrease
1
2
3
4
5
6
7
8
9
10
6
Practice
1. An increase in consumer spending
2. The impact on net exports when a trading
partner has a recession
3. A significant increase in the price of oil that
affects the resource costs of businesses
4. Government increases spending but not taxes
5. Increase in wages that businesses pay workers
6. Effect on businesses when they expect inflation
7. Effect on investment when interest rates
decrease
8. An increase in productivity
9. The impact on next exports when the country’s
currency depreciates
10. Government increases corporate taxes
7
Capital Goods
The economy can only be in one of
three places at any time
Max Capacity
0% Unemployment
Real
GDP
Real
GDP
Consumer Goods
Full Employment
5% Unemployment
Time
Recessionary Gap
Full Employment
Inflationary Gap
8
Example: Assume the government increases
spending. What happens to PL and Output?
Price
Level
LRAS
AS
PL and Q will
Increase
PL1
PLe
AD
QY Q1
AD1
GDPR
9
Inflationary Gap
Output is high and unemployment is less than NRU
LRAS
Price
Level
AS
Actual GDP
above potential
GDP
PL1
AD1
QY Q1
GDPR
10
Example: Assume consumer spending falls.
What happens to PL and Output?
LRAS
Price
Level
AS
PL and Q will
decrease
PLe
PL1
AD1
Q1
QY
AD
GDPR
11
Recessionary Gap
Output low and unemployment is more than NRU
LRAS
Price
Level
AS
Actual GDP
below potential
GDP
PL1
AD1
Q1
QY
GDPR
12
Example: If there is a negative “supply shock”
of oil. What happens to PL and Output?
Price
Level
LRAS
AS1
AS
Stagflation
PL1
Stagnate Economy
+ Inflation
PLe
Still considered
recessionary gap
AD
Q1 QY
GDPR
13
What Happens In
the Long-Run?
14
If consumer spending increases, what will
happen in the short-run and in the long-run?
In the long-run, wages and costs increase
LRAS
AS1
Real
GDP
Price
Level
AS
PL2
Real
GDP
PL1
PLe
AD AD1
QY Q1
GDPR
Time
15
If consumer spending increases, what will
happen in the short-run and in the long-run?
In the long-run, wages and costs increase
LRAS
AS1
Real
GDP
Price
Level
PLe
Real
GDP
AD1
QY
GDPR
Time
16
If consumer spending decreases, what will
happen in the short-run and in the long-run?
In the long-run, wages & costs eventually decrease
LRAS
Price
Level
AS
Real
GDP
AS2
PLe
PL1
Real
GDP
PL2
AD2 AD
Q1 QY
GDPR
Time
17
If investment increases, what happens in the
short-run and long-run?
Capital Stock- Machinery and tools purchased by
businesses that increase their output
LRAS LRAS1
AS AS1
PL1
PLe
QY
AD1
AD
Q1 QY1 GDPR
Capital Goods
Price
Level
The PPC shifts outward since
producers can make more
Consumer Goods
18
An increase in consumption or government
spending doesn’t cause economic growth.
Only Investment causes growth since firms
increase their capital stock
LRAS1
AS1
Capital Goods
Price
Level
PLe
AD1
QY1
GDPR
Consumer Goods
19