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Aggregate Demand and Aggregate Supply

Aggregate Demand and Aggregate Supply. SLIDES PREPARED BY JUDITH SKUCE, GEORGIAN COLLEGE. In this chapter you will learn. 8.1 What determines the shape of the aggregate demand curve and what factors shift the entire curve

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Aggregate Demand and Aggregate Supply

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  1. Aggregate Demand and Aggregate Supply SLIDES PREPARED BY JUDITH SKUCE, GEORGIAN COLLEGE Macroeconomics, Chapter 8

  2. In this chapter you will learn 8.1 What determines the shape of the aggregate demand curve and what factors shift the entire curve 8.2 What determines the shape of the aggregate supply curve, and what factors shift the entire curve 8.3 How the equilibrium price level and real GDP are determined 8.4 How the economy arrives at its long run equilibrium 8.5 Equilibrium vs. full-employment GDP Macroeconomics, Chapter 8

  3. Chapter 8 Topics 8.1 Aggregate Demand 8.2 Aggregate Supply 8.3 Equilibrium GDP & Changes in Equilibrium 8.4 From the Short Run to the Long Run 8.5 Equilibrium Versus Full-Employment GDP Macroeconomics, Chapter 8

  4. Aggregate Demand (AD) • The amounts of real output that buyers collectively desire to purchase at each possible price level Macroeconomics, Chapter 8

  5. Aggregate Demand (AD) Figure 8 - 1 Price Level AD Real GDP • Aggregate Quantity Demanded (Real GDP) and the Price Level are inversely related as follows: Macroeconomics, Chapter 8

  6. Aggregate Demand (AD) • slopes downward because of the following effects of a change in price level: • Real-balances Effect • Interest-rate Effect • Foreign Trade Effect Remember: these effects are caused by price level changes Macroeconomics, Chapter 8

  7. Changes in Aggregate Demand Price level AD1 Real domestic output, GDP Figure 8 - 2 AD Can Increase Macroeconomics, Chapter 8

  8. Changes in Aggregate Demand Price level AD1 Real domestic output, GDP Figure 8 - 2 AD Can Increase shift RIGHT AD2 Macroeconomics, Chapter 8

  9. Changes in Aggregate Demand Price level AD1 Real domestic output, GDP Figure 8 - 2 AD Can Decrease Macroeconomics, Chapter 8

  10. Changes in Aggregate Demand Price level AD1 Real domestic output, GDP Figure 8 - 2 AD Can Decrease shift LEFT AD3 Macroeconomics, Chapter 8

  11. Determinants of Aggregate Demand • Consumer Spending • Consumer wealth • Consumer expectations • Taxes • Household indebtedness Macroeconomics, Chapter 8

  12. Determinants of Aggregate Demand • Investment Spending • Real Interest Rates • Expected Returns • Expectations about future business conditions • Technology • Degree of excess capacity • Business taxes Macroeconomics, Chapter 8

  13. Determinants of Aggregate Demand • Government Spending • Net Export Spending • National Income Abroad • Exchange Rates Macroeconomics, Chapter 8

  14. Chapter 8 Topics 8.1 Aggregate Demand 8.2 Aggregate Supply 8.3 Equilibrium GDP & Changes in Equilibrium 8.4 From the Short Run to the Long Run 8.5 Equilibrium Versus Full-Employment GDP  Macroeconomics, Chapter 8

  15. Aggregate Supply • The level of real domestic output that will be produced at each price level • Production responses to price level changes differ in the long run & the short run Macroeconomics, Chapter 8

  16. Aggregate Supply in the Long Run ASLR • in the long run, the aggregate supply curve is vertical at the economy’s full-employment output (potential GDP) Price level Real domestic output, GDP GDPf Macroeconomics, Chapter 8

  17. Aggregate Supply in the Long Run • in the long run, wages & other input prices rise or fall to match changes in the price level • changes in the price level do not change real profit & there is no change in real output Macroeconomics, Chapter 8

  18. Aggregate Supply in the Short Run AS • in reality, nominal wages adjust only slowly to changes in the price level • short-run aggregate supply curve is upward-sloping Price level Real domestic output, GDP GDPf Macroeconomics, Chapter 8

  19. Aggregate Supply in the Short Run unless stated otherwise, “aggregate supply” refers to AS in the short run • as the economy expands in the short run, per-unit production costs generally rise • the extent of the rise depends on where the economy is operating, relative to its capacity • an economy operating below its full-employment output has idle capital & labourlittle upward pressure on production costs • when the economy is operating beyond its full-employment output, most available resources are already employedper-unit production costs increase as economy expands Macroeconomics, Chapter 8

  20. Determinants of Aggregate Supply • Change in input prices • Domestic resource price • Price of imported resources • Market power • Change in productivity • Change in legal-institutional environment • Business taxes & subsidies • Government regulation Macroeconomics, Chapter 8

  21. Chapter 8 Topics 8.1 Aggregate Demand 8.2 Aggregate Supply 8.3 Equilibrium GDP & Changes in Equilibrium 8.4 From the Short Run to the Long Run 8.5 Equilibrium Versus Full-Employment GDP   Macroeconomics, Chapter 8

  22. Equilibrium GDP • Equilibrium occurs at the price level that equalizes the amount of real output demanded & supplied • A price level too low would mean AD>AS, putting upward pressure on prices across the economy Macroeconomics, Chapter 8

  23. Price Level Too Low PL1 AS1 AD1 Figure 8-6 AS Price Level AD upward pressure Real GDP Macroeconomics, Chapter 8

  24. Equilibrium GDP • similarly, a price level too high would mean AD<AS, putting downward pressure on prices across the economy Macroeconomics, Chapter 8

  25. Price Level Too High PL2 AD2 AS2 Figure 8-6 AS Price Level AD downward pressure Real GDP Macroeconomics, Chapter 8

  26. Changes in Equilibrium • Are caused by changes (shifts) in AD and/or AS Macroeconomics, Chapter 8

  27. Increases in AD • for any initial increase in aggregate demand, the resulting increase in real output will be smaller the greater is the increase in the price level • demand-pull inflation… Macroeconomics, Chapter 8

  28. Increases in AD P2 AD2 GDP2 GDP1 output does not increase all the way to GDP1 because of inflation Figure 8-7 AS Price level P1 AD1 Real GDP GDPf Macroeconomics, Chapter 8

  29. Decreases in AD • Deflation is a rarity in the Canadian economy • Real output takes the full brunt of the decline in AD because product prices are “sticky” in the short run • wage contracts • morale, effort, & productivity • minimum wage • menu costs • fear of price wars Macroeconomics, Chapter 8

  30. Decreases in AD AD2 GDP1 prices are sticky downwards Figure 8-8 AS Price level P1 AD1 Real GDP GDPf Macroeconomics, Chapter 8

  31. Decreases in AS: Cost-Push Inflation • effects of a leftward shift in AS are doubly bad • output decreases • price level increases Macroeconomics, Chapter 8

  32. Decreases in AS AS2 P2 GDP2 Figure 8-9 AS1 Price level P1 AD1 Real GDP GDPf Macroeconomics, Chapter 8

  33. Increases in AS • increases in AD should normally lead to inflation • recently, productivity growth has shifted the long-run AS curve to the right Macroeconomics, Chapter 8

  34. Increases in AS AS2 P3 P2 AD2 GDP2 GDP3 Figure 8-10 AS1 Price level P1 AD1 Real GDP GDP1 Macroeconomics, Chapter 8

  35. Chapter 8 Topics 8.1 Aggregate Demand 8.2 Aggregate Supply 8.3 Equilibrium GDP & Changes in Equilibrium 8.4 From the Short Run to the Long Run 8.5 Equilibrium Versus Full-Employment GDP    Macroeconomics, Chapter 8

  36. From the Short Run to the Long Run • nominal wages & other input prices may remain constant in the short run, even though the price level has changed • once contracts have expired & nominal wage adjustments have been made, the economy enters the long run Macroeconomics, Chapter 8

  37. Short-Run Aggregate Supply P2 GDP2 Figure 8-11 an increase in price level increases profits & output, moving the economy from a1 to a2 AS1 a2 Price level a1 P1 GDPf Real domestic output Macroeconomics, Chapter 8

  38. Short-Run Aggregate Supply P3 GDP3 Figure 8-11 a decrease in price level decreases profits & output, moving the economy from a1 to a3 AS1 Price level a1 P1 a3 GDPf Real domestic output Macroeconomics, Chapter 8

  39. Long-Run Aggregate Supply AS2 Figure 8-11 an increase in price level leads to increases in nominal wages, shifting short-run AS leftward new equilibrium at b1 ASLR AS1 b1 a2 P2 Price level a1 P1 GDPf GDP2 Real domestic output Macroeconomics, Chapter 8

  40. Long-Run Aggregate Supply AS3 Figure 8-11 a decrease in price level leads to decreases in nominal wages, shifting short-run AS rightward new equilibrium at c1 ASLR AS1 Price level a1 P1 a3 P3 c1 GDP3 GDPf GDP2 Real domestic output Macroeconomics, Chapter 8

  41. Equilibrium in the Long-Run AD-AS Model Figure 8-12 ASLR AS1 Price level a P1 AD1 GDPf Macroeconomics, Chapter 8

  42. Chapter 8 Topics 8.1 Aggregate Demand 8.2 Aggregate Supply 8.3 Equilibrium GDP & Changes in Equilibrium 8.4 From the Short Run to the Long Run 8.5 Equilibrium Versus Full-Employment GDP     Macroeconomics, Chapter 8

  43. Equilibrium Versus Full-Employment GDP • There is no guarantee, in the short run, that equilibrium GDP will be full-employment GDP Macroeconomics, Chapter 8

  44. Recessionary Gap • A recessionary gap occurs when AD is too low, and equilibrium GDP is below potential GDP Macroeconomics, Chapter 8

  45. Recessionary Gap Recessionary Gap = 20 P1 AD1 490 Figure 8-13 ASLR Potential GDP AS Price level P0 AD0 510 Real GDP Macroeconomics, Chapter 8

  46. Inflationary Gap • An inflationary gap occurs when AD is too high, and equilibrium GDP is above potential GDP Macroeconomics, Chapter 8

  47. Inflationary Gap Inflationary Gap = 20 P1 AD2 530 Figure 8-13 ASLR Potential GDP AS Price level P0 AD0 510 Real GDP Macroeconomics, Chapter 8

  48. Chapter 8 Topics 8.1 Aggregate Demand 8.2 Aggregate Supply 8.3 Equilibrium GDP & Changes in Equilibrium 8.4 From the Short Run to the Long Run 8.5 Equilibrium Versus Full-Employment GDP      Macroeconomics, Chapter 8

  49. Chapter 8 Appendix The Relationship of the Aggregate Expenditures Model to the AD-AS Model Macroeconomics, Chapter 8

  50. Derivation of AD Curve • AD can be derived from the Aggregate Expenditures Model illustrated… Macroeconomics, Chapter 8

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