Isues in economics today 6th by guell chapter08

Chapter 08 Aggregate Demand and Aggregate Supply McGraw-Hill/Irwin Copyright © 2012 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 McGraw-Hill/Irwin ©2012 The McGraw-Hill Companies, All Rights Reserved 8-2 1-2 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 McGraw-Hill/Irwin ©2012 The McGraw-Hill Companies, All Rights Reserved 8-3 1-3 Figure Aggregate Demand PI AD RGDP McGraw-Hill/Irwin ©2012 The McGraw-Hill Companies, All Rights Reserved 8-4 1-4 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 McGraw-Hill/Irwin ©2012 The McGraw-Hill Companies, All Rights Reserved 8-5 1-5 Aggregate Supply • Aggregate Supply: the level of real domestic output available at each possible price level McGraw-Hill/Irwin ©2012 The McGraw-Hill Companies, All Rights Reserved 8-6 1-6 Figure The Aggregate Supply Curve AS PI Classical Range Intermediate Range Keynesian Range RGDP McGraw-Hill/Irwin ©2012 The McGraw-Hill Companies, All Rights Reserved 8-7 1-7 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 McGraw-Hill/Irwin ©2012 The McGraw-Hill Companies, All Rights Reserved 8-8 1-8 Variables that Shift Aggregate Demand • • • • • Taxes Interest Rates Confidence Strength of the Dollar Government Spending McGraw-Hill/Irwin ©2012 The McGraw-Hill Companies, All Rights Reserved 8-9 1-9 Determinants of AD Variable GDP Compone nt C,I,G,X Effect of an increase on AD Effect of a decrease on AD Taxes C,I Decrease so AD Interest Rates C,I Decrease so AD Confidence C,I Increase so AD => Decrease so AD 8-10 McGraw-Hill/Irwinimports)©2012 The McGraw-Hill Companies, All Rights Reserved 1-10 Figure AD Increases PI AS PI’ PI* AD’ AD RGDP* McGraw-Hill/Irwin RGDP’ RGDP ©2012 The McGraw-Hill Companies, All Rights Reserved 8-11 1-11 Figure AD Decreases PI AS PI* PI’ AD AD’ RGDP’ McGraw-Hill/Irwin RGDP* RGDP ©2012 The McGraw-Hill Companies, All Rights Reserved 8-12 1-12 Variables that Shift AS • Input Prices • Productivity • Government Regulation McGraw-Hill/Irwin ©2012 The McGraw-Hill Companies, All Rights Reserved 8-13 1-13 Determinants of AS Variable Effect of an Increase on AS Input Prices Decrease so AS Productivity Increase so AS Governmen Decrease McGraw-Hill/Irwin Effect of an Decrease on AS Increase so AS Decrease so AS Increase so ©2012 The McGraw-Hill Companies, All Rights Reserved 8-14 1-14 Figure Increase in AS PI AS AS’ PI* PI’ AD RGDP* McGraw-Hill/Irwin RGDP’ RGDP ©2012 The McGraw-Hill Companies, All Rights Reserved 8-15 1-15 Figure Decrease in AS PI AS’ AS PI’ PI* AD RGDP’ McGraw-Hill/Irwin RGDP* RGDP ©2012 The McGraw-Hill Companies, All Rights Reserved 8-16 1-16 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 McGraw-Hill/Irwin ©2012 The McGraw-Hill Companies, All Rights Reserved 8-17 1-17 Government Influence: Aggregate Demand • Government can influence economic activity with aggregate demand side policies affecting: • Taxes • Government Spending • Interest Rates McGraw-Hill/Irwin ©2012 The McGraw-Hill Companies, All Rights Reserved 8-18 1-18 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 McGraw-Hill/Irwin ©2012 The McGraw-Hill Companies, All Rights Reserved 8-19 1-19 ... Pull Inflation: inflation caused by an increase in aggregate demand • Cost Push Inflation: inflation caused by a decrease in aggregate supply McGraw-Hill/Irwin ©2012 The McGraw-Hill Companies, All... Government Influence: Aggregate Supply • Government can influence economic activity with aggregate supply side policies affecting • input costs (labor and wage) • reducing regulation • Increase incentives... Decrease in AS PI AS’ AS PI’ PI* AD RGDP’ McGraw-Hill/Irwin RGDP* RGDP ©2012 The McGraw-Hill Companies, All Rights Reserved 8-16 1-16 Causes of Inflation • Demand Pull Inflation: inflation caused by