Transcript Chapter 8 Aggregate Demand and Aggregate Supply

Chapter 8
Aggregate Demand and
Aggregate Supply
McGraw-Hill/Irwin
Copyright © 2010 by The McGraw-Hill Companies, Inc. All rights reserved.
Chapter Outline
• Aggregate Demand
• Aggregate Supply
• Shifts in Aggregate Demand and
Aggregate Supply
• Causes of Inflation
• Supply-Side Economics
• How the Government can Influence
(but probably not control) the
economy
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You Are Here
8-3
Aggregate Demand
• Aggregate Demand: the amounts
of real domestic output which
domestic consumers, businesses,
governments, and foreign buyers
collectively will desire to purchase at
each possible price level
8-4
Figure 1 Aggregate Demand
PI
AD
RGDP
8-5
Why Aggregate Demand is
Downward Sloping
• Real Balances Effect
– Because higher prices reduce real spending power,
prices and output are negatively related.
• Foreign Purchases Effect
– When domestic prices are high, we will export less
to foreign buyers and we will import more from
foreign producers. Therefore higher prices leads to
less domestic output.
• Interest Rate Effect
– higher prices lead to inflation which leads to less
borrowing and a lowering of RGDP
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Aggregate Supply
• Aggregate Supply: the level of real
domestic output available at each
possible price level
8-7
Figure 2 The Aggregate Supply
Curve
AS
PI
Classical
Range
Intermediate
Range
Keynesian Range
RGDP
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The Ranges of AS
• Keynesian Range
– Large amounts of unemployment make it so
that increases in aggregate demand have no
affect on wages or prices.
• Classical Range
– Full employment makes it so that increases in
aggregate demand only increase wages or
prices.
• Intermediate Range
– Some sectors of the economy reach full
employment more quickly than others.
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Variables that Shift Aggregate
Demand
•
•
•
•
•
Taxes
Interest Rates
Confidence
Strength of the Dollar
Government Spending
8-10
Determinants of AD
Variable
Taxes
GDP
Component
C,I,G,X
C,I
Interest Rates
C,I
Confidence
C,I
Strength of the X (exportsDollar
imports)
Government
Spending
G
Effect of an
Effect of a
increase on AD decrease on AD
Decrease so
AD <=
Decrease so
AD <=
Increase so
AD =>
Decrease so
AD <=
Increase so
AD =>
Increase so
AD =>
Increase so
AD =>
Decrease so
AD <=
Increase so
AD =>
Decrease so
AD <=
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Figure 3 AD Increases
PI
AS
PI’
PI*
AD’
AD
RGDP*
RGDP’
RGDP
8-12
Figure 4 AD Decreases
PI
AS
PI*
PI’
AD
AD’
RGDP’
RGDP*
RGDP
8-13
Variables that Shift AS
• Input Prices
• Productivity
• Government Regulation
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Determinants of AS
Variable
Effect of an
Increase on AS
Effect of an
Decrease on AS
Input Prices
Decrease so
AS
Increase so
AS
Decrease so
AS
Increase so
AS
Decrease so
AS
Increase so
AS
Productivity
Government
Regulation
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Figure 5 Increase in AS
PI
AS
AS’
PI*
PI’
AD
RGDP*
RGDP’
RGDP
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Figure 6 Decrease in AS
PI
AS’
AS
PI’
PI*
AD
RGDP’
RGDP*
RGDP
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Causes of Inflation
• Demand Pull Inflation: inflation
caused by an increase in aggregate
demand
• Cost Push Inflation: inflation caused
by a decrease in aggregate supply
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Government Influence:
Aggregate Demand
• Government can influence economic
activity with aggregate demand side
policies affecting:
– Taxes
– Government Spending
– Interest Rates
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Government Influence:
Aggregate Supply
• Government can influence economic activity
with aggregate supply side policies affecting
– input costs (labor and wage)
– reducing regulation
– Increase incentives to
• Work
• Take Risks
• The actions are call Supply Side Economics
8-20