Transcript Macroeconomics

Chapter 11: Aggregate
Demand & Aggregate Supply
Aggregate Demand (AD) – Aggregate
Supply (AS) model is a variable price
model.
AD – AS model provides insights on
inflation, unemployment, and economic
growth
Aggregate Demand
A schedule that shows the various
amounts of real domestic output that
domestic & foreign buyers will desire to
purchase at each possible price level
Shows an inverse relationship between
price level and domestic output
Price v. Real GDP: Reasons
for Inverse Relationship
Real Balances Effect: When Price falls,
purchasing power of existing financial
balances rises  increase spending
Interest Rate Effect: A decline in Price means
lower interest rates  increase levels of
certain types of spending
Foreign Purchases Effect: When Price falls,
US prices will fall relative to foreign pries 
increase spending on US exports, decrease
import spending in favor of US products that
compete w/ imports
Determinants of Aggregate
Demand
Real GDP = C + Ig + G + Xn
Changes
Changes
Changes
Changes
in
in
in
in
Consumer Spending
Investment Spending
Governments Spending
Net Exports
Changes in Consumer
Spending
Consumer Wealth
Consumer Expectations
Consumer Indebtedness
Taxes
Changes in Investment
Spending
Interest Rates
Profit Expectations
Business Taxes
Technology
Amount of Excess Capacity
Change in Government
Spending
This is Fiscal Policy (Chapter 12)
Changes in Net Exports
When unrelated to price level:
Income Abroad
Exchange Rates


Depreciation of $ encourages US exports since US
products become less expensive for foreign
buyers, who can now obtain $ for their currency
Depreciation of $ discourages import buying in the
US since it is more expensive for Americans to
exchange foreign currency
Aggregate Supply
A schedule showing level of Real GDP
available at each Price
Higher Prices create an incentive for
firms to produce & sell more
Lower Prices prompt firms to reduce
output
Direct/Positive relationship between P &
Real GDP
Determinants of Aggregate
Supply
Change in Input Prices
Change in Productivity
Change in Legal-Institutional
Environment
Change in Input Prices
Availability of Resources

Land, Labor, Capital, & Entrepreneurial
Ability
Prices of Imported Resources
Market Power in Certain Industries
Change in Productivity
Productivity = Real Output / Input
Changes in Per-unit Production Cost = Total
Input Cost / Units of Output
If productivity rises, unit production costs fall
 Shifts AS to right, lowers Prices
If productivity falls, unit production costs rise
 Shifts AS to left, increasing Prices
Legal – Institutional
Environment
Business Taxes
Subsidies
Government Regulation
Equilibrium:
Price v. Real Output
Equilibrium Price and Quantity are
found where AD and AS curves intersect
Decreases in AD
If AD decreases, recession and cyclical
unemployment may result
Wage contracts are not flexible, business
can’t afford to reduce prices
Employers are reluctant to cut wages b/c
impact on EE effort
Minimum Wage Laws keep wages up
Menu Costs are difficult to change
Fear of price wars keeps prices from being
reduced
Why is Unemployment in
Europe So High?
High minimum wages
Generous welfare benefits for unemployed
Restrictions against firings discourage
employment
30 – 40 days of paid vacation & holidays
increase costs of hiring
High worker absenteeism reduces
productivity
Higher employer cost of fringe benefits
discourages hiring
Chapter 11 Study Questions
7, 8: Determinants of AD & AS