Transcript AD/AS Model - Gore High School

A.S 3.5
AD/AS Model
Aggregate = Total
Aggregate Demand = Total demand in the economy
Aggregate Supply = Total supply in the economy
Aggregate Demand Curve
• Shows the total demand in an economy at
each price level
• Price Level = general level of prices (Measures
inflation)
• Aggregate demand is demand from each of
the sectors of the economy
Aggregate Deamand
• AD = consumption spending (c) + Investment spending
(I) + government spending (g) + net exports[exports (x)
– Imports (m)]
• AD = C + I + G + (X-M)
• If any of the components increases, then AD will
increase and cause the AD curve to shift to the right
• If any of these components decreases, the AD will
decrease and cause the AD curve to shift to the left
AD
C
I
G
X
M
income
interest
rates
Govt
spending
decisions
exchange
rate
exchange
rate
overseas
demand
tastes
preferences
overseas
trade
barriers e.g.
tariffs
NZ trade
barriers e.g.
tariffs
direct tax/
income tax
business
confidence
consumer
confidence
interest
rates
inflationary
expectations/ future prices
tastes/
preferences
Shifts of the AD curve
Aggregate Supply
• The aggregate supply curve shows the total output
in an economy at each price level
• The aggregate supply curve is drawn assuming that
– Nominal wages (Cost of production)
– Import prices (cost of raw materials)
– Productivity ( influenced by investment and technology)
Are all held constant
If any of these three factors change then there will be a
shift of the AS curve
AS
 nominal wages
Imported
raw materials
cost
exchange
rates
overseas
price
productivity
technology
skilled labour
leaving NZ
Indirect Tax
GST tax
excise tax
Technology
Shifts of the AS curve
Equilibrium
Occurs where AD=AS
Price
Level
This level also indicates
• The price level Ple (Inflation
rate)
• the level of employment ,
output and Real GDP (Ye)
Equilibrium AD/AS
YF shows full employment.
YF - Ye shows the level
unemployment level that exists
PLe
Ye
YF
Real GDP
(Output and
employment)
Equilibrium represents where the
economy will tend to move
towards. Once we are at this
equilibrium the economy will stay
here unless AD or AS moves
.
• Task sheets 3, 4 and 6 – Aggregate demand
• Task sheet 5 and 7 – Aggregate Supply
• Workbooks page 193
Using the AD/AS model to illustrate
Inflation
• Inflation = any increase in the general price
level in the economy
• There are two changes on the AD/AS model
that will result in inflation
1. Increase in AD
2. Decrease in AS
Increase in AD (Demand Pull Inflation)
• Any factor that causes a rise in AD, will cause a rise
in the general level of prices, this is called demand
pull inflation
PL2
Inflation
occurring
PL1
Decrease in AS (Cost Push Inflation)
• Any factor that causes a fall in AS, will cause a rise
in the general level of prices, this is called cost
push inflation
PL2
Inflation
occurring
PL1
• Task sheet 8 and 9
• Workbooks 194 – 196
Using the AD/AS model to illustrate
Economic Growth
• Economic growth = increase in the amount of goods and
services produced in an economy (Shown as an increase
in Real GDP)
• Gross Domestic Product (GDP) = Total value of all goods
and services produced in an economy in a year
• Nominal GDP = Current dollar value of the production of
goods and services produced
• Real GDP = Nominal GDP with the effects of inflation
removed
Changes to AD curve and Growth
- Any increase in AD will cause an increase in
economic growth.
- If any component of AD increases then growth
will occur
- E.G. An increase in consumption spending,
causes firms to increase output to meet the
increase in demand. This causes firms to increase
employment resulting in an increase in incomes.
Output increases so RGDP increases
Increase in AD
PL1
PLe
AD’
Ye
Y1
Any increase in Real GDP shows
economic growth
Changes to AS and Growth
• The factor that will increase AS curve (Cause a
shift to the right) will result in economic
growth
– Costs of production fall
– Productivity/ Technology Increases
– NZ dollar appreciates (Costs of imported raw
materials fall)
Increase in AS
AS’
e.g. NZ dollar Appreciates
Cost of imported raw
materials fall, so firms
costs of production
decreases.
Firms respond by
increasing supply as its
now more profitable due
to costs falling. (Profit =
Revenue –Costs)
Causes AS curve to shift
to the right from AS to
AS’ as supply increases.
PLe
PL1
Ye
Y1
Causes real GDP to
increase from Ye to Y1
resulting in economic
growth.
• Read and highlight page 204
• Complete pages 205 -207
AD/AS and Unemployment
• Unemployment = People who don’t have a job
and are actively seeking employment
THE BUSINESS CYCLE
PEAK/
BOOM
Economic
activity
% Change
in RGDP
PEAK/
BOOM
TROUGH
TROUGH
Time
The Business Cycle
 Peak / upswing –





High Economic Activity
Low unemployment
High Investment
Consumer and business confidence is high.
High Inflationary Pressure
 Downturn/Recession






Reduced economic activity
High Unemployment
Reduced investment
Unemployment increasing
Consumer and business confidence is low
Disinflation or deflation occurring
Recessionary Gap •
Yf shows full employment
• When the economy is in a
recession, demand for
goods and services falls.
Therefore producers lay
off workers as their
profits begin to fall.
Price
Level
Recessionary Gap
• Unemployment rises.
PL
• This is shown as the gap
between Y and Yf
Y
Yf
Unemployment
Why is a Recessionary (Defaltionary) gap
unfavourable?

Equilibrium income is below full employment level of income
resulting in
 Unemployment
 Idle Factories

This is a concern to the government because, even though the
economy is in equilibrium there is under-utilised resources in
the economy i.e. unemployed workers
Closing the recessionary Gap
• To decrease unemployment we need an
increase in output to occur.
• Any factor that will lead to an increase in
output (RGDP) will close the recessionary Gap
• Occur from either
– Increase in AD
– Increase in AS
• Read and Highlight page 220
• Complete pages 221 - 222
Trade and the Current Account
Balance
 We
have several different exchange rates, one for
each currency.
 It
measures how much we would get in terms of
the other currency per $1 NZ.
 If
an exchange rate increases, our $NZ is
appreciating.

This means that we are now getting more of the
other currency per $1 NZ.


Causes exports to become more expensive for foreign
consumers
Causes imports to become cheaper for us.
 If
an exchange rate is decreasing, our $NZ is
depreciating.

This means that we are now getting less of the
other currency per $1 NZ.


Causes exports to become cheaper and more competitive
overseas
Causes imports to become more expensive for us
 When
we buy goods or services from other countries
we must pay them in their currency. Therefore we
must sell (SUPPLY) our dollar in return for the other
currency.

Hence why we have exchange rates, we need to know how
much of other countries currency we would get in return for
every $1 NZ.
 This
also works in reverse: when other countries want
to buy our exports they must sell their currency in
return for our $NZ (DEMAND for the $NZ) in order
to pay for the goods.
 This
means that the ‘market’ (demand and supply) for
our NZ dollar determines the exchange rate.
 Things
that will increase the demand for the $NZ:
Exports increase (more demand for our $NZ to pay
for these)
 Foreigners investing in NZ (they must invest in NZ in
our currency) i.e. our interest rate is high.
 Borrowing from abroad (they must lend us the money
in $NZ in order for us to use it)
 Increase in tourists coming to NZ.

 Things
that will increase the supply of the $NZ:
Imports increase (we need to sell more of our $ to
get more of the foreign currency to pay for these)
 NZer’s invest more overseas (we must invest in the
currency that the country uses i.e. Japan-Yen)
 Paying back loans to overseas lenders.
 More NZer’s traveling overseas (we must sell our
$NZ to get the currency to spend in the country we
are traveling overseas).

Appreciation of NZ dollar
Depreciation of NZ dollar
measures the purchasing power of a nation’s
exports (in terms of what we receive for exports and what
we pay for our imports).
 This
T
of T = Index of export prices × 1000
Index of imported prices
 When
it becomes more expensive to buy imports our
purchasing power decreases (ToT).
 When
it becomes less expensive to buy imports our
purchasing power increases (ToT).
Balance of Payments
• Where New Zealand's international
transactions are summarised
• International transactions include the value of
– Inflows and outflows of money
– Financial assets and liabilities
Financial Account
Capital Account
Balance of
Payments
Current Account
1st part to the current account
Balance on goods
• Measures relationship between nations exports and
imports of GOODS.
Exports of goods
Export receipts
Imports of Goods
Import Payments
• Calculated as Export receipts – Import Payments
2nd part to the current account
Balance on services
• We sell our services overseas and we buy other services
from overseas. They include tourism, insurance and
transport.
Exports of services
Export receipts
Import payments
Import of Services
• Calculated as services receipts – service payments
3rd part to Current Account
Balance on Incomes
• New Zealand Producers invest money in overseas
businesses in order to earn income, and overseas
producers do the same in NZ.
• Net result of this = Balance on Incomes
• Calculated as Income from investments aboard –
incomes paid to foreign investors
• e.g. Interest on savings loans and dividends on
shares
4th part to current account
Balance on current transfers
• Nz makes payments to overseas governments
in the form of international aid.
• E.g Aid to assist Fiji for devastating cyclone.
• Transfers also include pension payments
received by the NZ government from overseas
governments for their citizens that now live in
NZ.
Current Account
Balance
on goods
Balance
On services
Value of
exported goods
minus value
imported goods
Value exported
services minus
value of imported
services
Usually positive
e.g. Transport,
insurance,
education etc.
Includes all
tangible items
that can be
seen, moved or
stored
Tourists from
overseas who
spend money in
NZ contribute to
our exports of
services
Balance
on income
Value of investment
income received
from investments
overseas minus
investment income
paid to foreign
investors
e.g. Interest on
savings loans and
dividends on shares
Balance
on current ‘
transfers
Value of
transfers
received by
NZlanders
minus value of
transfers paid
to others
overseas.
e.g. Money
transfers from
Govt aid, gifts
etc
How to calculate Current Account
•
•
•
•
•
Balance on Current Account =
Balance on goods +
Balance on services +
Balance on Incomes +
Balance on current transfers
Current account balance 1999-2006
Positive balances indicate a surplus, negative balances are in deficit
-The goods balance has gone from a surplus of $2.1 billion in 2001 to a deficit of $4.2
billion in 2006
-- Mainly driven from rising imports
-- Service balance went from deficit to small surplus
-- Investment income deficit increased to over 11billion in 2006
-- result of increasing income earned by foreign investors (high foreign investment)
Current Account Balance
Is
consistently in deficit.
NZ has experienced current account deficits since
the 1970s.
 NZ has a large foregin ownership of NZ companies
 The Balance on Income account negative (More
money leaving NZ than coming into NZ)


This deficit has to be paid for in some way, from
overseas borrowing, foreign investment or assets sales

Foreign Investment causes interest rates to rise.

This reduces AD and decreases economic growth
.

Read and Highlight 213 and 214

Workbook page 215