Lecture Economics (19/e) - Chapter 29: Aggregate demand and aggregate supply

After reading this chapter, you should be able to: Define aggregate demand (AD) and explain the factors that cause it to change; define aggregate supply (AS) and explain the factors that cause it to change; discuss how AD and AS determine an economy''s equilibrium price level and level of real GDP; describe how the AD-AS model explains periods of demand-pull inflation, cost-push inflation, and recession; identify how the aggregate demand curve relates to the aggregate expenditures model.

29 AggregateDemandandAggregate Supply McGrawưHill/Irwin Copyrightâ2012byTheMcGrawưHillCompanies,Inc.Allrightsreserved AggregateDemand Real GDP desired at each price level • Inverse relationship • Real balances effect • Interest effect • Foreign purchases effect LO1 29-2 Price level Aggregate Demand AD LO1 Real domestic output, GDP 29-3 Price level Changes in Aggregate Demand AD2 AD3 AD1 Real domestic output, GDP LO1 29-4 Consumer Spending • Consumer wealth • Household borrowing • Consumer expectations • Personal taxes LO1 29-5 Investment Spending • Real interest rates • Expected returns • Expectations about future business conditions • Technology • Degree of excess capacity • Business taxes LO1 29-6 Government Spending • Government spending increases • Aggregate demand increases (as • LO1 long as interest rates and tax rates not change) • More transportation projects Government spending decreases • Aggregate demand decreases • Less military spending 29-7 Net Export Spending • National income abroad • Exchange rates • Dollar depreciation • Dollar appreciation LO1 29-8 Aggregate Supply • Total real output produced at each • LO2 price level Relationship depends on time horizon • Immediate short run • Short run • Long run 29-9 AS: Immediate Short Run Price level Immediate-short-run aggregate supply P1 ASISR Qf Real domestic output, GDP LO2 29-10 Aggregate Supply: Short Run AS Price level Aggregate supply (short run) Qf Real domestic output, GDP LO2 29-11 Aggregate Supply: Long Run Price level ASLR Long-run aggregate supply Qf Real domestic output, GDP LO2 29-12 Changes in Aggregate Supply • Determinants of aggregate supply • Shift factors • Collectively position the AS curve • Changes raise or lower per-unit production costs LO2 29-13 Changes in Aggregate Supply AS3 AS1 Price level AS2 Real domestic output, GDP LO2 29-14 Input Prices • Domestic resource prices • Labor • Capital • Land • Prices of imported resources • Imported oil • Exchange rates LO2 29-15 Productivity • Real output per unit of input • Increases in productivity reduce costs • Decreases in productivity increase costs Productivity = Per-unit production cost LO2 total output total inputs = total input cost total output 29-16 Legal­Institutional Environment • Legal changes alter per-unit costs of output • Taxes and subsidies • Extent of government regulation LO2 29-17 Price level (index numbers) Equilibrium AS 100 92 a b Real Output Demanded (Billions) Price Level (Index Number) Real Output Supplied (Billions) $506 108 $513 508 104 512 510 100 510 512 96 507 514 92 502 AD 502 510 514 Real domestic output, GDP (billions of dollars) LO3 29-18 Increases in AD: Demand­Pull Inflation Price level AS P2 P1 AD2 AD1 Qf Q1 Q Real domestic output, GDP LO4 29-19 Decreases in AD: Recession Price level AS P1 P2 b a c AD1 AD2 Q1 Q Qf Real domestic output, GDP LO4 29-20 Decreases in AS: Cost­Push Inflation Price level AS2 P2 P1 AS1 b a AD Q Qf Real domestic output, GDP LO4 29-21 Increases in AS: Full­Employment Price level AS1 P3 P2 P1 AS2 b a c AD2 AD1 Q1 Q2 Q3 Real domestic output, GDP LO4 29-22 ... output, GDP LO2 2 9-1 1 Aggregate Supply:  Long Run Price level ASLR Long-run aggregate supply Qf Real domestic output, GDP LO2 2 9-1 2 Changes in Aggregate Supply • Determinants of aggregate supply • Shift... Long run 2 9-9 AS: Immediate Short Run Price level Immediate-short-run aggregate supply P1 ASISR Qf Real domestic output, GDP LO2 2 9-1 0 Aggregate Supply:  Short Run AS Price level Aggregate supply. . .Aggregate Demand • Real GDP desired at each price level • Inverse relationship • Real balances effect • Interest effect • Foreign purchases effect LO1 2 9-2 Price level Aggregate Demand AD