Ch 10. Aggregate Demand and Aggregate Supply

1. Ch 10. Aggregate Demand and Aggregate Supply

2. Aggregate Demand-Aggregate Supply model (AD-AS model). • Enables us to analyze changes in real GDP and the price level simultaneously. • Provides insights on inflation, recession, unemployment, and economic growth.

3. A. Aggregate Demand – schedule or graph that shows the amounts of real output that buyers collectively desire to purchase at each possible price level. -- Aggregate Demand = all demand together.

4. AS D 0 Real domestic output, GDP The aggregate demand curve: downsloping indicates an inverse (negative) relationship between the price level and the amount of real output purchased. Also downsloping due to real wealth balance effect (how we feel about market), foreign trade effect (P =  sales), and interest rate effect.

5. Change in Aggregate Demand • A change in the determinants of AD will SHIFT the AD curve. • Right shift from AD1 to AD2 shows an increase in AD. • Left shift from AD1 to AD3 shows a decrease. AD3

6. Changes in Aggregate Demand Changes in Aggregate Demand Curve Increase in Aggregate Demand Price Level Decrease in Aggregate Demand AD2 AD1 AD3 Real Domestic Output, GDP

7. B. Aggregate Supply – schedule or graph showing the level of real output that firms will produce at each possible price level. -- AS = supply of everything in our economy (U.S. GDP). -- Sticky Wages = labor contracts stuck at a certain level.

8. Aggregate Supply

9. 1. Aggregate Supply in the Long- Run (ASLR) – vertical at full- employment level of real GDP (Qf). 2003 -- Long run – In Microeconomics, a period of time long enough to enable producers of a product to change the quantities of all the resources they employ.

10.  Price =  real output.  Price =  real output. Aggregate Supply (short-run) PL Upsloping AS curve indicates a direct (or positive) relationship between the price level and the amount of real output that Firms will offer for sale. 2. AS in the short-run (ASSR) Price Level Qf Q Real domestic output, GDP -- Short-run – In Microeconomics, a period in time in which producers are able to change the quantities of some, but not all of the resources they employ. -- If price-level rises, output increases, and profits increase because wages are fixed. -- Wages are fixed and sticky because of contracts, unawareness.

12. Total Output = Productivity Total Inputs Total Output 10 = = 2 Total Inputs 5 Changes in Aggregate Supply Understanding Productivity

13. -- Aka aggregate supply shifters. -- Change in Aggregate Supply 3. Determinants of AS Which is a decrease and which is an increase?

14. Changes in Aggregate Supply Changes in Aggregate Supply Curve AS3 AS1 Decrease in Aggregate Supply AS2 Price Level Increase in Aggregate Supply Real Domestic Output, GDP

15. (a) shows decreases & increases in price level. • (b) shows decreases & increases in aggregate supply.

16. C. Equilibrium – intersection of the AS & AD curves. -- Equilibrium price level and equilibrium real output = intersection. -- AS & AD jointly establish the price level and level of real GDP.

17. AD/AS Model PL AS (Factors of Production) shifting • AS: Factors of Productions (land, labor, capital, & entrepreneurial); can also include business tax & business regulation. • AD: Consumer expenditures, bus. investment, gov’t expend. & net exports. • The “I” in AD is business investment on demand side because the market demands payment. Pe AD (C + I + G + Xn) shifts 0 Qe Q

18. Equilibrium and Changes in Equilibrium Tabular View… Real Output Demanded (Billions) Real Output Supplied (Billions) Price Level (Index Number) $506 508 510 512 514 108 104 100 96 92 $513 512 510 507 502 Equilibrium Price Level and Equilibrium Price Level

19. Equilibrium and Changes in Equilibrium AS Price Level Equilibrium 100 92 b a AD 502 510 514 Real Domestic Output, GDP (Billions of Dollars)

20. In the short-run Prices  Real GDP  D. Increases in AD: Demand-Pull Inflation – price level is being pulled up by increase in AD. Qf Q1

21. Equilibrium and Changes in Equilibrium Increase in Aggregate Demand AS Demand-Pull Inflation P2 Price Level P1 AD1 AD Qf Q1 Q2 Real Domestic Output, GDP

22. -- AS = Factors of Productions (land, labor, capital, & entrepreneurial); can also include business tax & business regulation. -- AD = C + I + G + Xn. -- A decrease in aggregate demand that causes a recession. -- A negative GDP gap of Q1 minus Qf results. P1 a b E. Decrease in AD: recession & cyclical unemploy- ment. Q1 Qf

23. Equilibrium and Changes in Equilibrium Decrease in Aggregate Demand AS Price Level b a P1 c P2 Creates a Recession AD1 AD2 Q1 Q2 Qf Real Domestic Output, GDP

24. “Cut in gov’t spending” P2 Q2 Q Q -- AD = C + I + G + Xn -- AS = Factors of Production

25. “During a Recession” PL LRAS AS Pe Qe  Unem  AD2 AD1 Q O

26. Price Level AS2 AS1 P2 P1 b F. Decrease in AS: Cost-push Inflation a Q Q1 Qf Real domestic output, GDP -- A decrease in AS that causes cost-push inflation. Cost-Push Inflation: • Supply shock causes increase in price level, • Govt has a policy dilemma, either higher price level or lower economic output.

27. Equilibrium and Changes in Equilibrium Decrease in Aggregate Supply AS1 AS Cost-Push Inflation b P2 Price Level a P1 AD Q1 Qf Real Domestic Output, GDP

28. Increase in productivity, but not in wages (sticky wages?!?) PL AS1 Q  PL  Unem  AS2  AD Q O

29. “Decrease in Int’l value of Dollar” PL AS PL QL  Unem  PL2  PL1  AD2 AD1 Q O Q2 Q1

30. PL AS2 AS1 b P3 P2 P1 c a G. Increase in AS: full employment w/ price-level stability. Price Level AD2 AD1 Q O Q1 Q2 Q3 Real domestic output, GDP -- Growth, full-employment, and relative price stability.

31. Equilibrium and Changes in Equilibrium Increases in Aggregate Supply – Full-Employment With Price-Level Stability AS1 AS2 P3 b c P2 a P1 Price Level AD2 AD1 Q1 Q2 Q3 Real Domestic Output, GDP

32. What’s happening here?

33. A significant decline in aggregate demand that causes a recession, • An excessive increase in aggregate demand can cause demand-pull inflation.