Chapter 12 - Aggregate demand and aggregate supply. This chapter introduces the concepts of aggregate demand and aggregate supply, explaining the shapes of the aggregate demand and aggregate supply curves and the forces that cause them to shift.
Chapter 12 Aggregate Demand and Aggregate Supply McGrawHill/Irwin Copyright © 2014 by The McGrawHill Companies, Inc. All rights reserved 11 121 Aggregate Demand • Real GDP desired at each price level • Inverse relationship • Real balances effect • Interest effect • Foreign purchases effect 122 Price level Aggregate Demand AD Real domestic output, GDP 123 Changes in Aggregate Demand • Determinants of aggregate demand • Change in consumer spending • Change in investment spending • Change in government spending • Change in export spending 124 Price level Changes in Aggregate Demand AD2 AD3 AD1 Real domestic output, GDP 125 Consumer Spending • Consumer wealth • Household borrowing • Consumer expectations • Personal taxes 126 Investment Spending • Real interest rates • Expected returns • Expectations about future business conditions • Technology • Degree of excess capacity • Business taxes 127 Investment Spending 128 Government Spending • Government spending increases • Aggregate demand increases (as long • as interest rates and tax rates not change) • More transportation projects Government spending decreases • Aggregate demand decreases • Less military spending 129 Net Export Spending • National income abroad • Exchange rates • Dollar depreciation • Dollar appreciation 1210 Aggregate Supply • Total real output produced at each • price level Relationship depends on time horizon • Immediate short run • Short run • Long run 1212 AS: Immediate Short Run Price level Immediate-short-run aggregate supply P1 ASISR Qf Real domestic output, GDP 1213 Aggregate Supply: Short Run AS Price level Aggregate supply (short run) Qf Real domestic output, GDP 1214 Aggregate Supply: Long Run Price level ASLR Long-run aggregate supply Qf Real domestic output, GDP 1215 Changes in Aggregate Supply • Determinants of aggregate supply • Change in input prices • Change in productivity • Change in legal-institutional • • LO2 environment Collectively position the AS curve Changes raise or lower per-unit production costs 1216 Changes in Aggregate Supply AS3 AS1 Price level AS2 Real domestic output, GDP 1217 Input Prices • Domestic resource prices • Labor • Capital • Land • Prices of imported resources • Imported oil • Exchange rates 1218 Productivity • Real output per unit of input • Increases in productivity reduce costs • Decreases in productivity increase costs Productivity = Per-unit production cost Total output Total inputs = Total input cost Total output 1219 LegalInstitutional Environment • Legal changes alter per-unit costs of output • Taxes and subsidies • Extent of government regulation LO2 1220 Price level (index numbers) Equilibrium AS 100 92 a b AD 502 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 92 502 510 514 Real domestic output, GDP (billions of dollars) 1221 AD Increases: DemandPull Inflation Price level AS P2 P1 AD2 AD1 Qf Q1 Q2 Real domestic output, GDP 1222 Decreases in AS: CostPush Inflation Price level AS2 P2 P1 AS1 b a AD Q1 Qf Real domestic output, GDP 1223 Downward PriceLevel Inflexibility • Prices are downwardly inflexible • Fear of price wars • Menu costs • Wage contracts • Efficiency wages • Minimum wage law 1224 Decreases in AD: Recession Price level AS P1 P2 b a c AD1 AD2 Q1 Q Qf Real domestic output, GDP 1225 The Multiplier Effect • Shifts in AD embody an “initial • change” in spending Price levels and average wage levels are becoming more flexible downward Multiplier = Change in real GDP Initial change in spending 1226 ... Immediate short run • Short run • Long run 12 12 AS: Immediate Short Run Price level Immediate-short-run aggregate supply P1 ASISR Qf Real domestic output, GDP 12 13 Aggregate Supply: Short Run AS... domestic output, GDP 12 14 Aggregate Supply: Long Run Price level ASLR Long-run aggregate supply Qf Real domestic output, GDP 12 15 Changes in Aggregate Supply • Determinants of aggregate supply... output, GDP 12 17 Input Prices • Domestic resource prices • Labor • Capital • Land • Prices of imported resources • Imported oil • Exchange rates 12 18 Productivity • Real output per unit of input