Transcript AD - West Ada

Unit 3:
Aggregate Demand and
Supply and Fiscal Policy
1
3.1 Aggregate
Demand
Three Facts About Economic Fluctuations
FACT 1: Economic fluctuations are
irregular and unpredictable.
$11,000
U.S. real GDP,
billions of 2000 dollars
10,000
9,000
8,000
7,000
6,000
The shaded
bars are
recessions
5,000
4,000
3,000
2,000
1965
1970
1975
1980
1985
1990
1995
2000
2005
Three Facts About Economic Fluctuations
FACT 2: Most macroeconomic
quantities fluctuate together.
$ 1,800
1,600
Investment spending,
billions of 2000 dollars
1,400
1,200
1,000
800
600
400
200
1965
1970
1975
1980
1985
1990
1995
2000
2005
Three Facts About Economic Fluctuations
FACT 3: As output falls, unemployment
rises.
12
Unemployment rate,
percent of labor force
10
8
6
4
2
0
1965
1970
1975
1980
1985
1990
1995
2000
2005
Aggregate Demand Curve
Price
Level
Applies similar concepts as the
demand curve, except instead of
dealing with the demand of one
good, we are talking about the
demand for all goods and services
in an economy.
AD
Real domestic output (GDPR)
6
What is Aggregate Demand?
Aggregate- “added all together.”
When we use aggregates
we combine all prices and all quantities.
Aggregate Demand is all the goods and services
(real GDP) that buyers are willing and able to
purchase at different price levels.
The Demand for everything by everyone in the US.
AD = C + I + G + Xn
7
What is Price Level?
Price Level- General level of prices for goods and
services in an economy. If all prices stay fixed for a
while, the price level is unchanged, too. When
inflation takes place, the price level arises.
If the price level:
• Increases (inflation), then real GDP demanded falls.
• Decreases (deflation), the real GDP demanded increases.
There is an inverse relationship
between
price level and Real GDP.
8
Aggregate Demand Curve
Price
Level
AD is the demand by consumers,
businesses, government, and
foreign countries
Changes in price level cause
a movement along the curve
AD = C + I + G + Xn
Real domestic output (GDPR)
9
Is AD downward sloping because
of the law of demand?
NO!
• The demand curve for an individual good shows how
the quantity demand depends on the price of that
good, holding the prices of other goods and services
constant
• The main reason the quantity demanded falls as price
goes up is because consumers switch to other
relatively inexpensive goods
• Movement up or down the aggregate demand curve
are a simultaneous change in the prices of all final
goods and services
10
3 Reasons the AD curve is
downward sloping:
1. The Wealth Effect
• Higher price levels reduce the purchasing
power of money.
• Lower price levels increase purchasing power
and increase expenditures
11
3 Reasons the AD curve is
downward sloping:
1. The Wealth Effect cont.
Examples:
• Henry has $5,000 in his bank account.
– If the aggregate price level were to rise by 25%, that
$5,000 would buy only as much as $4,000 would have
bought previously. What is Henry going to do?
– The loss of purchasing power means Henry will scale back
what he is going to buy
• If the price level doubles, people are going to buy
less stuff because they have less purchasing power.
• So…price level goes up, GDP demanded goes down.
12
3 Reasons the AD curve is
downward sloping:
2. Interest-Rate Effect-
• When the price level increases, people and
firms must hold onto more money to purchase
the same amount of goods
• Thus, lenders have less money and need to
charge higher interest rates to get a REAL
return on their loans.
• Higher interest rates discourage consumer
spending and business investment.
13
3 Reasons the AD curve is
downward sloping:
2. Interest-Rate Effect Continued-
• When the price level falls, households
need to hold less money to buy the goods
and services they want.
• Households might use its excess money
to buy bonds or deposit it in a bank, thus
lowering interest rates
Example: An increase in prices leads to an increase in
the interest rate from 5% to 25%. You are less likely to
take out loans to improve your business.
So…price level goes up, GDP demanded goes down.
14
3 Reasons the AD curve is
downward sloping:
3. Foreign Trade (Net Export)Effect• When U.S. price level rises, foreign buyers
purchase fewer U.S. goods and Americans
buy more foreign goods
• Exports fall and imports rise causing real
GDP demanded to fall. (XN Decreases)
Example: If prices triple in the US, Canada will no
longer buy US goods causing quantity demanded of US
products to fall.
• So…price level goes up, GDP demanded goes down
15
Aggregate Demand Curve
Price
Level
Changes in price level cause
a movement along the curve
AD = C + I + G + Xn
Real domestic output (GDPR)
16
Shifters of
Aggregate Demand
AD = GDP = C + I + G + Xn
17
Shifts in Aggregate Demand
An increase in spending shift AD right,
and decrease in spending shifts it left
Price
Level
AD1
AD2
AD = C + I + G + Xn
Real domestic output (GDPR)
18
4 Shifters of Aggregate Demand
1. Change in Consumer Spending
Increase in Disposable Income (Higher incomes…)
Consumer Expectations (People fear a recession…)
Household Indebtedness (More consumer debt…)
Taxes (Decrease in income taxes…)
AD = GDP = C + I + G + Xn
19
4 Shifters of Aggregate Demand
2. Change in Investment Spending
Real Interest Rates (Price of borrowing $)
(If interest rates increase—AD shifts left…)
Future Business Expectations
(High expectations—AD shifts right…)
Existing stock of physical capital
(If relatively small—AD shifts right…)
Business Taxes
(Higher corporate taxes means—AD shift left…)
AD = GDP = C + I + G + Xn
20
Shifters of Aggregate Demand
3. Change in Government Spending
Government Expenditures
(Decrease in defense spending—AD shift left…)
(Increase in public works programs—AD shift
right…)
AD = GDP = C + I + G + Xn
21
Shifters of Aggregate Demand
4. Change in Net Exports (X-M)
Exchange Rates
(If the us dollar depreciates relative to the euro—
AD shifts right…)
National Income Compared to Abroad
(If a major importer has a recession—AD shift
left…)
AD = GDP = C + I + G + Xn
22
Draw 8 AD Curves and Show the
Results of the Following:
23
Shifts in Aggregate Demand
Scenario: A widespread fear of impending recession
Price
Level
C ↓ and I ↓,
so AD ↓
AD2
AD = C + I + G + Xn
Real domestic output (GDPR)
24
Shifts in Aggregate Demand
Scenario: A significant boom in the stock market.
Price
Level
C ↑ , so AD ↑
AD1
AD = C + I + G + Xn
Real domestic output (GDPR)
25
Shifts in Aggregate Demand
Scenario: An increase in the incomes of a close trading
partner
Price
Exports
↑
,
Level
so AD ↑
AD1
AD = C + I + G + Xn
Real domestic output (GDPR)
26
Shifts in Aggregate Demand
Scenario: A decrease in government spending
Price
Level
G ↓ , so AD ↓
AD2
AD = C + I + G + Xn
Real domestic output (GDPR)
27
Shifts in Aggregate Demand
Scenario: A ten-year-old investment tax credit expires.
Price
Level
I ↓ , so AD ↓
AD2
AD = C + I + G + Xn
Real domestic output (GDPR)
28
Shifts in Aggregate Demand
Scenario: The U.S. exchange rate falls.
Price
Level
Exports ↑ ,
so AD ↑
AD1
AD = C + I + G + Xn
Real domestic output (GDPR)
29
Shifts in Aggregate Demand
Scenario: A fall in prices increases the real value of
consumers’ wealth.
Price
Wealth
Level
effect, so
moves along
AD
AD = C + I + G + Xn
Real domestic output (GDPR)
30
Shifts in Aggregate Demand
Scenario: State government replace their sales taxes
with new taxes on interest, dividends, and capital gains.
Price
Level
C ↑ , so AD ↑
AD1
AD = C + I + G + Xn
Real domestic output (GDPR)
31
32
Look what happened during the
last 5 recessions:
33