1 / 25

WEEK V

WEEK V. Aggregate Demand and Supply. Week V. Keynesian Macroeconomic Model Transmission. Theory of Liquidity Preference. Keynesian Cross. LM Curve. IS Curve. IS-LM Model. AD Curve. AS Curve. Economic fluctuations. Week V. Aggregate Supply (AS)

deborah-powers
Download Presentation

WEEK V

An Image/Link below is provided (as is) to download presentation Download Policy: Content on the Website is provided to you AS IS for your information and personal use and may not be sold / licensed / shared on other websites without getting consent from its author. Content is provided to you AS IS for your information and personal use only. Download presentation by click this link. While downloading, if for some reason you are not able to download a presentation, the publisher may have deleted the file from their server. During download, if you can't get a presentation, the file might be deleted by the publisher.

E N D

Presentation Transcript

  1. WEEK V Aggregate Demand and Supply

  2. Week V Keynesian Macroeconomic Model Transmission Theory of Liquidity Preference Keynesian Cross LM Curve IS Curve IS-LM Model AD Curve AS Curve Economic fluctuations

  3. Week V Aggregate Supply (AS) • AS captures the effect of output (Y) on the price level (P). AS is derived from the behavior of wage setting (WS) and price setting (PS). • P = (1 + m)W • P = (1 + m) PeF(u, z) • By replacing u in the equation by 1 – (Y/L): • AS relation: P = Pe (1 + m) F[1 - (Y/L), z] • Interpretation AS relation: • An increase in output (Y), while Pe constant, leads to an increase in the price level (P): • Y   N  • N   U  & u  • u   W  • W   P 

  4. Week V • An increase in expected price (Pe), while u constant, leads to an increase in the price level (P): • Pe  W  • W   Cost  • Cost   P  • If actual output (Y) = natural level of output (Yn), thus P = Pe • Based on above characteristics, 3 properties of AS curve: • Upward sloping; a positive relationship between Y and P • Goes through a point (e.g. A) in which Y = Yn and P = Pethus this implies: • Y > Yn P > Pe • Y < Yn P < Pe

  5. Week V

  6. Week V Based on above characteristics, 3 properties of AS curve (continued): Changes Pein will shift AS curve

  7. Week V • Aggregate Demand (AD) • AD captures the effect of the price level (P) on output (Y). AD is derived from the equilibrium in the goods market (IS) and financial market (LM) • IS : Y = C(Y – T) + I(Y, i) + G • LM: (M/P) = Y, L(i) • (M/P): real money stock which its changes depend on changes in nominal money (M) of the bank central and price level (P). Therefore: • P  (= M )  (M/P)  • (M/P)   i  • i   I   Z   Y 

  8. Week V

  9. Week V

  10. Week V AS & AD: Equilibrium condition • AS relation: P = Pe (1 + m) F[1 - (Y/L), z] • Short run (SR): Peconstant • At point A (AS intersect AD): all of markets [goods, financial (represented by AD curve) and labor (represented by AS curve)] is in equilibrium in which output level = Y and price level = P. • Y ≠ Ynand P ≠ Pe

  11. Week V • The SR equilibrium: Y >Yn

  12. Week V • Medium and long run (LR): Pechanges • Y =Yn • due to an automatic adjustment process over time: • Y > Ynthus Pt > Pet-1 • Pet > Pet-1 • Pe  Wt+1  Costt+1  • Costt+1   Pt+1  • AS curve shifts upward to achieve Y =Ynin LR • Y decreases by moving along the AD curve (i.e. via M/P  I  Z/AD  Y)

  13. Week V The dynamics of automatic adjustment in LR

  14. Week V Dynamic effects of policies & external shocks • Expansionary monetary policy: M • SR: • M  (M/P)   Y  • LM curve shifts downward  i   I   Z/AD  • AD : AD curve shifts to the right  P  • Equilibrium condition in SR at A with P’ and Y’ • Y > Yn

  15. Week V • Effect expansionary monetary policy on interest rate and output

  16. Week V • Expansionary monetary policy: M • Over time (LR): adjustment of Pe(Pe<P) and shifting AS curve upward until : • Equilibrium condition in LR at A” with P” and Y” • Y” =Yn • AS curve upward : P  • since higher P offsets the increase in M thus (M/P) is back to its initial value • M  P  but NO effect on Y and I called as the neutrality of money in the medium and long run. • Expansionary monetary policy can help the economy to move out of recession (Y < Yn) and return to natural level of output.

  17. Week V Effect of expansionary monetary policy on output and price level: SR and LR

  18. Week V • Contractionary fiscal policy: G • SR: • G   Z/AD   Y  • AD curve shifts to the left  P  • IS curve shifts to the left  i  • P   (M/P)  LM curve shift downward  i  further • Equilibrium condition in SR at A with P’ and Y’ • Y’ < Yn

  19. Week V • Effect contractionary fiscal policy on interest rate and output

  20. Week V • Contractionary fiscal policy: G • In LR: adjustment of Pe(Pe>P) thus: • P   (M/P) • LM curve shift downward • i • Y = C(Yn – T) + I(Yn, i) + G in which Yn and T are unchanged, G  and I  (due to i ) • Equilibrium condition in LR at A” with P” and Y” • Y” = Yn

  21. Week V Effect of contractionary fiscal policy on output and price

  22. Week V • External shocks: Increase in world oil price • SR: • Oil Price   m (oil as cost of energy) • m : PS curve shifts downward  W/P  & u  • AS curve shifts upward  P  & Y • Equilibrium condition in SR at A’ with P’ and Y’ • Y’ < Yn

  23. Week V Effect of increase in world oil price on unemployment

  24. Week V Effect of increase in world oil price on output and price

  25. Week V • Increase in oil price • Over time: adjustment of Yn(recall: un) thus: • AS curve shifts to upward  Yn  • Therefore Y’n< Y makes Pe and AS curve shifts upward further • P  further and Yuntil Y=Yn • Equilibrium condition in LR at A” with Y’n

More Related