Transcript Chapter 24 The Aggregate Supply–Aggregate Demand Model

PRINCIPLES OF ECONOMICS
Chapter 24 The Aggregate Supply–Aggregate Demand Model
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THE HOUSING MARKET
Between 2000 and 2006, a housing bubble was formed. At the peak of
the housing bubble, many people across the country were able to
secure the loans necessary to build new houses. Banks gave loans to
many homeowners who did not have enough income to qualify. In late
2006/early 2007, the housing bubble burst, causing prices to crash and
foreclosures to mount
THE HOUSING MARKET
From the early 1990s up through 2005, the number of new single
family houses sold rose steadily. In 2006, the number dropped
dramatically and this dramatic decline continued through 2011. In
2012, the number sold rose a bit over previous years, but it was
still lower than the number of new houses sold in 1990.
Product Market: The market in which goods and
services are exchanged and in which the
equilibrium level of GDP is determined.
Money Market: The market in which financial
instruments (money, bonds, and stocks) are
exchanged and in which the equilibrium rate of
interest is determined.
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MAJOR MARKETS IN THE ECONOMY
Aggregate Demand (AD): The
relationship between Real GDP and the
general level of price.
Each point on the AD shows a pair of
income and price, which brings both
product and money markets to
equilibrium.
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THE AGGREGATE DEMAND
THE AGGREGATE DEMAND
Aggregate Demand slopes down, showing that, as
the price level rises, the amount of total spending
on goods and services declines.
AGGREGATE SUPPLY
Aggregate Supply (AS) shows the relationship
between total output supplied by all firms and the
general price level.
Aggregate Supply traces out the price and output
decisions of all the markets and firms.
SHORT-RUN AGGREGATE SUPPLY
The shape of AS depends
on productive capacity of the
economy.
AS is inverted L-shaped.
At low levels of output with
high unemployment, AS is
fairly flat.
As the economy approaches
full capacity, AS gains a
positive slope.
At full capacity, the AS
becomes nearly vertical.
AS slopes up because rising prices induce
firms to produce more and earn higher
profits.
The “potential” GDP line shows the
maximum that the economy can produce
with full employment of workers and
physical capital. In the long-run AS
becomes a vertical line.
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AGGREGATE SUPPLY
AGGREGATE SUPPLY
AGGREGATE EQUILIBRIUM
AD = SRAS = LRAS at potential GDP (Y0)
AGGREGATE EQUILIBRIUM
Short-run equilibrium is achieved at less
than full-employment
a) The rise in productivity causes the SRAS curve to
shift to the right. Increases in AS, lead to a
greater level of output and a lower level of price.
b) Rising input prices means a lower quantity will be
produced so AS shift to the left from AS0 to AS1.
Decrease in AS results in reduced output, but a
higher price.
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SHIFT IN AGGREGATE SUPPLY
SHIFT IN AGGREGATE SUPPLY
a) Improvement in consumer or business confidence
shifts AD to the right, getting the economy closer
to potential GDP. An increase in government
spending or a cut in taxes also shifts AD to the
right.
b) Worsening consumer or business confidence
shifts AD to the left, getting the economy farther
from potential GDP. A decrease in government
spending or higher taxes also shifts AD to the left.
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SHIFT IN AGGREGATE DEMAND
SHIFT IN AGGREGATE DEMAND
SHIFT IN AGGREGATE DEMAND
Whether the economy is in a recession is illustrated in the
AD-AS model by how close the equilibrium is to the
potential GDP. In this example, an increase in AD can get
the economy closer to full employment.
EFFECT OF AGGREGATE DEMAND POLICY
An increase in AD when the economy is operating at low levels of
output is likely to result in an increase in output with a small increase
in the price level.
As the economy approaches full-employment, firms respond to further
increases in AD by raising prices to cover higher production costs.