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Lecture #1 chapter 24 Aggregate Demand and Supply Analysis

Lecture #1 chapter 24 Aggregate Demand and Supply Analysis. Monetarist View of AD. P  Y 2000 V = ——— = —–— = 2 M 1000 Modern Quantity Theory of Money M  V = P  Y Implication: M determines P  Y Deriving AD Curve M = 1000, V = 2  P  Y = 2000

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Lecture #1 chapter 24 Aggregate Demand and Supply Analysis

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  1. Lecture #1 chapter 24 Aggregate Demand and Supply Analysis

  2. Monetarist View of AD P Y 2000 V = ——— = —–— = 2 M 1000 Modern Quantity Theory of Money M V = P Y Implication:M determines P Y Deriving AD Curve M = 1000, V = 2 P Y = 2000 Point A: P = 2 Y = 1000 PY = 21000 Point B: P = 1 Y = 2000 PY = 12000 Point C: P = .5 Y = 4000 PY =.54000 Conclusion:PY, downward sloping AD Shift in AD Curve M: PY, so at given P, YAD shifts right

  3. The AD Curve

  4. Keynesian View of AD Yad = C + I + G + NX Downward Sloping AD P, M/P, i, I, NX, Yad Shift in AD M, M/P, i, I, NX, Yad AD shifts right C or G or T  or NX: Yad AD shifts right Complete Crowding Out G, iC, I, NX C + I + G + NX = Yad unchanged Partial crowding out: private spending down, but not fully offsetting G

  5. Aggregate Supply in Short-run Upward slope of AS In short-run production costs fixed P, profits , Y produced  Shift in AS Production costs : At given P, profits , YY shifts right

  6. Equilibrium in Short-Run Equilibrium: AD = AS If P > P*, AS > ADP to P* If P < P*, AS < ADP to P*

  7. Equilibrium in the Long-Run Panel (a): Y > Yn Wages : at given P, profits , Y produced AS shifts in until Y = Yn at long-run AS Panel (b): Y < Yn Wages : at given P, profits , Y produced AS shifts out until Y = Yn at long-run AS Activist sees movement to long-run AS (self-correcting mechanism) as slow; nonactivist sees as fast

  8. Summary: Factors that Shift AD

  9. Effect of Shift in AD on Y 1. AD shifts right: YP to point 1' 2. Y > Yn: wages , AS shifts in until reach point 2, where Y = Yn Conclusion: AD shifts right, Y in short-run only; in long-run only P

  10. Summary: Factors that Shift AS

  11. Effect of Shift in AS on Y 1. Negative supply shock: AS shifts in, YP to point 2 2. Y < Yn: wages , AS shifts out until return to point 1 Conclusion: AS shifts in, YP in short-run, but in long-run Y and P are unchanged

  12. Shifts in Long-Run Supply Yn grows over time, but is shown as fixed in AD/AS diagram Real Business Cycle Theory 1. Yn fluctuates a lot due to aggregate supply (real) shocks 2. Shifts in AD small 3. Conclusion: Business cycles due to real shocks 4. Supports nonactivism Hysteresis 1. AD shifts in, natural rate of unemployment , Yn shifts in 2. Unemployment stays high 3. Supports activism

  13. Vietnam War Buildup: 1964–70

  14. Negative Supply Shocks: 1973–75 and 1978–80

  15. Phillips Curve and AS Phillips Curve w/w = – h (U – Un) Implication: When U > Un, i.e., Y < Ynw, AS shifts in Expectations Augmented Phillips Curve w/w – e = – h (U – Un) or w/w = – h (U – Un) + e

  16. Phillips Curve

  17. Implications of ExpectationsAugmented Phillips Curve 1. When e, Phillips Curve shifts up 2. U deviates from Un only when there are surprises about inflation Solving above for U U = Un – (w/w – e)/h  substituted for w/w cause move together U = Un – ( – e)/h 3. Can’t buy U permanently below Un by higher  In long-run  = e: so from eq. above, U = Un

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