Chapter 29 - Aggregate demand and aggregate supply. This chapter 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.
Chapter 29 Aggregate Demand and Aggregate Supply McGrawHill/Irwin Copyright © 2009 by The McGrawHill Companies, Inc. All rights reserved Chapter Objectives • Aggregate demand (AD) • Aggregate supply (AS) • How AD and AS determine equilibrium price and real GDP • The AD-AS model 29-2 Aggregate Demand • Amount of real GDP purchased at each price level • Why the downward slope? – Real-balances effect – Interest-rate effect – Foreign purchases effect • Consumption, investment, and net exports 29-3 Price Level Aggregate Demand Curve Aggregate Demand AD Real Domestic Output, GDP 29-4 Aggregate Demand • Determinants of aggregate demand – Fixed variables along the demand curve • Change in fixed variable • Multiplier effect • Consumer spending variables: – Consumer wealth – Consumer expectations – Household borrowing – Personal taxes 29-5 Aggregate Demand • Investment spending variables – Real interest rates – Expected returns • Future business conditions • Technology • Degree of excess capacity • Business taxes 29-6 Aggregate Demand • Government spending • Net export spending variables • National income abroad • Exchange rates 29-7 Changes in Aggregate Demand Price Level Increase in Aggregate Demand Decrease in Aggregate Demand AD2 AD3 AD1 Real Domestic Output, GDP 29-8 Aggregate Supply • Amount real GDP produced at each price level • Three time horizons • Immediate short run – Few days to a few months – All prices fixed – Implicit price agreements – Contractual agreements 29-9 Aggregate Supply Price Level ASISR Immediate-shortrun Aggregate Supply Qf Real Domestic Output, GDP 29-10 Aggregate Supply AS3 AS1 AS2 Price Level Decrease in Aggregate Supply Increase in Aggregate Supply Real Domestic Output, GDP 29-15 Equilibrium 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 Equilibrium Price Level and Equilibrium Real GDP 29-16 Equilibrium Price Level AS Equilibrium 100 92 a b AD 502 510 514 Real Domestic Output, GDP (Billions of Dollars) 29-17 Changes in Equilibrium Increase in Aggregate Demand Price Level AS P2 Demand-Pull Inflation P1 AD1 AD Qf Q1 Q Real Domestic Output, GDP 29-18 Changes in Equilibrium Decrease in Aggregate Demand Price Level AS b P1 a c P2 Creates a Recession AD1 AD2 Q1 Q2 Qf Real Domestic Output, GDP 29-19 Changes in Equilibrium • Decrease in aggregate demand – Recession and cyclical unemployment – Deflation? • Downward price inflexibility: – Fear of price wars – Menu costs – Wage contracts – Morale, effort, and productivity • Efficiency wages – Minimum Wage 29-20 Changes in Equilibrium Decrease in Aggregate Supply Price Level AS2 Cost-Push Inflation P2 P1 AS1 b a AD Q1 Qf Real Domestic Output, GDP 29-21 Changes in Equilibrium Increases in Aggregate Supply – Full-Employment With Price-Level Stability Price Level AS1 P3 P2 P1 AS2 b a c AD2 AD1 Q1 Q2Q3 Real Domestic Output, GDP 29-22 Impact of Oil Prices • Aggregate supply shocks • Cost push inflation • Oil prices affected core inflation prior to 1980 • Core inflation unaffected post 1980 – Energy efficiency – Composition of GDP – Fed vigilance 29-23 Key Terms • aggregate demandaggregate supply (ADAS) model • aggregate demand • real-balances effect • interest-rate effect • foreign purchases effect • determinants of aggregate demand • aggregate supply • immediate-short-run aggregate supply curve • short-run aggregate supply curve • long-run aggregate supply curve • determinants of aggregate supply • productivity • equilibrium price level • equilibrium real output • menu costs • efficiency wages 29-24 Next Chapter Preview… Fiscal Policy, Deficits, and Debt 29-25 Appendix The Relationship of the Aggregate Demand Curve to the Aggregate Expenditures Model Deriving the AD Curve Aggregate Expenditures (billions of dollars) AE1 (at P1 ) AE2 (at P2 ) AE3 (at P3 ) As Price Levels Increase… Price Level 45° P3 Real GDP Declines P2 P1 AD Q1 Q2 Q3 Real Domestic Product, GDP 29-27 Deriving the AD Curve AE2 (at P1 ) Aggregate Expenditures AE1 (at P1 ) Increase in Aggregate Expenditures Price Level 45° Increase in Aggregate Demand P1 AD2 AD1 Q1 Q2 Real Domestic Product, GDP 29-28 Deriving the AD Curve AE2 (at P1 ) Aggregate Expenditures AE1 (at P1 ) The Shift in the Aggregate Demand Curve is a Multiple of the initial Change in Aggregate Expenditures Price Level 45° P1 AD2 AD1 Q1 Q2 Real Domestic Product, GDP 29-29 ... price agreements – Contractual agreements 2 9- 9 Aggregate Supply Price Level ASISR Immediate-shortrun Aggregate Supply Qf Real Domestic Output, GDP 2 9- 10 Aggregate Supply • Short run – Input prices... Efficiency wages – Minimum Wage 2 9- 20 Changes in Equilibrium Decrease in Aggregate Supply Price Level AS2 Cost-Push Inflation P2 P1 AS1 b a AD Q1 Qf Real Domestic Output, GDP 2 9- 21 Changes in Equilibrium... level • equilibrium real output • menu costs • efficiency wages 2 9- 24 Next Chapter Preview… Fiscal Policy, Deficits, and Debt 2 9- 25 Appendix The Relationship of the Aggregate Demand Curve to the