Economics Textbook PDF - Aggregate Demand & Supply

CHAPTER 8 AGGREGATE DEMAND...

CHAPTER 8 AGGREGATE DEMAND AND ECONOMICS Roger A. Arnold Thirteenth Edition AGGREGATE SUPPLY ©2019 Cengage Learning. All Rights Reserved. May not be scanned, copied or duplicated, or posted to a publicly accessible website, in whole or in part. ©Sashkin/Shutterstock  8-1 A Way to View the Economy 8-2 Aggregate Demand 8-3 Short-Run Aggregate Supply 8-4 Putting AD and SRAS Together: Short-Run Equilibrium 8-5 Long-Run Aggregate Supply 2 ©2019 Cengage Learning. All Rights Reserved. May not be scanned, copied or duplicated, or posted to a publicly accessible website, in whole or in part. ©SashkinShutterstock  8-1 A Way to View the Economy (1 of 2) This chapter begins our theoretical discussion of an economy We can think of it as consisting of two major activities: buying and producing (See Exhibit 1) When economists speak about aggregate demand (AD), they are speaking about the buying side When they speak about aggregate supply, they are speaking about the producing side 3 ©2019 Cengage Learning. All Rights Reserved. May not be scanned, copied or duplicated, or posted to a publicly accessible website, in whole or in part. ©SashkinShutterstock  8-1 A Way to View the Economy (2 of 2) The framework of analysis we use is called aggregate demand – aggregate supply (AD – AS) That framework of analysis has three parts: 1. Aggregate demand (AD) 2. Short-run-aggregate supply (SRAS) 3. Long-run aggregate supply (LRAS) 4 ©2019 Cengage Learning. All Rights Reserved. May not be scanned, copied or duplicated, or posted to a publicly accessible website, in whole or in part. ©SashkinShutterstock  EXHIBIT 1 An Economy 5 ©2019 Cengage Learning. All Rights Reserved. May not be scanned, copied or duplicated, or posted to a publicly accessible website, in whole or in part. ©SashkinShutterstock  8-2 Aggregate Demand (1 of 12) Aggregate Demand: The quantity demanded of all goods and services (Real GDP) at different price levels, ceteris paribus Aggregate Demand Curve: A curve that shows the quantity demanded of all goods and services (Real GDP) at different price levels, ceteris paribus 6 ©2019 Cengage Learning. All Rights Reserved. May not be scanned, copied or duplicated, or posted to a publicly accessible website, in whole or in part. ©SashkinShutterstock  EXHIBIT 2 The Aggregate Demand Curve 7 ©2019 Cengage Learning. All Rights Reserved. May not be scanned, copied or duplicated, or posted to a publicly accessible website, in whole or in part. ©SashkinShutterstock  8-2 Aggregate Demand (2 of 12) 8-2a Why Does the Aggregate Demand Curve Slope Downward? Real Balance Effect: The change in the purchasing power of dollar-denominated assets that results from a change in the price level Monetary Wealth: The value of a person’s monetary assets. Wealth, as distinguished from monetary wealth, refers to the value of all assets owned, both monetary and nonmonetary. In short, a person’s wealth equals his or her monetary wealth (e.g., $1,000 cash) plus nonmonetary wealth (e.g., a car or a house) 8 ©2019 Cengage Learning. All Rights Reserved. May not be scanned, copied or duplicated, or posted to a publicly accessible website, in whole or in part. ©SashkinShutterstock  8-2 Aggregate Demand (3 of 12) 8-2a Why Does the Aggregate Demand Curve Slope Downward? (cont) Because of three effects: – Purchasing Power: The quantity of goods and services that can be purchased with a unit of money. Purchasing power and the price level are inversely related. As the price level goes up (down), purchasing power goes down (up) – Interest Rate Effect: The changes in household and business buying as the interest rate changes (in turn, a reflection of a change in the demand for or supply of credit brought on by price level changes) – International Trade Effect: The change in foreign sector spending as the price level changes 9 ©2019 Cengage Learning. All Rights Reserved. May not be scanned, copied or duplicated, or posted to a publicly accessible website, in whole or in part. ©SashkinShutterstock  EXHIBIT 3 Why the Aggregate Demand Curve is Downward Sloping (1 of 2) 10 ©2019 Cengage Learning. All Rights Reserved. May not be scanned, copied or duplicated, or posted to a publicly accessible website, in whole or in part. ©SashkinShutterstock  EXHIBIT 3 Why the Aggregate Demand Curve is Downward Sloping (2 of 2) 11 ©2019 Cengage Learning. All Rights Reserved. May not be scanned, copied or duplicated, or posted to a publicly accessible website, in whole or in part. ©SashkinShutterstock  8-2 Aggregate Demand (4 of 12) 8-2b An Important Word on the Three Effects The aggregate demand curve is downward sloping because of the real balance, interest rate, and international trade effects Keep in mind that what caused these three effects is a change in the price level Why is this point important? The interest rate can change as a result of things other than the price level changing, and not everything that changes the interest rate leads to a movement from one point to another point on the AD curve Other things that change the interest rate can lead to a shift in the AD curve instead 12 ©2019 Cengage Learning. All Rights Reserved. May not be scanned, copied or duplicated, or posted to a publicly accessible website, in whole or in part. ©SashkinShutterstock  8-2 Aggregate Demand (5 of 12) 8-2c A Change in Quantity Demanded of Real GDP Versus a Change in Aggregate Demand As the price level falls, the quantity demanded of Real GDP rises, ceteris paribus In Exhibit 4(a), a change in the quantity demanded is represented as a movement from one point (A) on AD1 to point (B) on AD1 A change in aggregate demand is represented in Exhibit 4(b) as a shift in the aggregate demand curve from AD1 to AD2 When the aggregate demand curve shifts, the quantity demanded of Real GDP changes even though the price level remains constant 13 ©2019 Cengage Learning. All Rights Reserved. May not be scanned, copied or duplicated, or posted to a publicly accessible website, in whole or in part. ©SashkinShutterstock  EXHIBIT 4 A Change in the Quantity Demanded of Real GDP Versus a Change in the Aggregate Demand 14 ©2019 Cengage Learning. All Rights Reserved. May not be scanned, copied or duplicated, or posted to a publicly accessible website, in whole or in part. ©SashkinShutterstock  8-2 Aggregate Demand (6 of 12) 8-2d Changes in the Aggregate Demand: Shifts in the AD Curve Aggregate demand changes when spending on U.S. goods and services changes: 8-2e How Spending Components Affect Aggregate Demand 15 ©2019 Cengage Learning. All Rights Reserved. May not be scanned, copied or duplicated, or posted to a publicly accessible website, in whole or in part. ©SashkinShutterstock  8-2 Aggregate Demand (7 of 12) 8-2e How Spending Components Affect Aggregate Demand (cont) We can relate the components of spending to U.S. aggregate demand: The flowcharts in Exhibit 5 show how changes in spending components affect aggregate demand 16 ©2019 Cengage Learning. All Rights Reserved. May not be scanned, copied or duplicated, or posted to a publicly accessible website, in whole or in part. ©SashkinShutterstock  EXHIBIT 5 Changes in Aggregate Demand 17 ©2019 Cengage Learning. All Rights Reserved. May not be scanned, copied or duplicated, or posted to a publicly accessible website, in whole or in part. ©SashkinShutterstock  8-2 Aggregate Demand (8 of 12) 8-2f Why Is There More Total Spending? Aggregate demand rises only if total spending rises at a given price level Total spending can rise for one of two reasons: – The first deals with a decline in prices and leads to a movement along a given AD curve – The second deals with a change in some factor other than prices and leads to a shift in the AD curve 18 ©2019 Cengage Learning. All Rights Reserved. May not be scanned, copied or duplicated, or posted to a publicly accessible website, in whole or in part. ©SashkinShutterstock  8-2 Aggregate Demand (9 of 12) 8-2g Factors That Can Change C, I, G, and NX (EX-IM) and Therefore Can Change AD (Shift the AD Curve) Wealth: The value of all assets owned, both monetary and nonmonetary Four factors can affect consumption: wealth, expectations about future prices and income, the interest rate, and income taxes Three factors can change investment: the interest rate, expectations about future sales, and business taxes Two factors can change net exports: foreign real national income and the exchange rate 19 ©2019 Cengage Learning. All Rights Reserved. May not be scanned, copied or duplicated, or posted to a publicly accessible website, in whole or in part. ©SashkinShutterstock  8-2 Aggregate Demand (10 of 12) 8-2g Factors That Can Change C, I, G, and NX (EX-IM) and Therefore Can Change AD (Shift the AD Curve) (cont) Exchange Rate: The price of one currency in terms of another currency Appreciated: An increase in the value of one currency relative to other currencies Depreciated: A decrease in the value of one currency relative to other currencies – Depreciation in a nation’s currency makes foreign goods more expensive 20 ©2019 Cengage Learning. All Rights Reserved. May not be scanned, copied or duplicated, or posted to a publicly accessible website, in whole or in part. ©SashkinShutterstock  EXHIBIT 6 Factors That Change Aggregate Demand 21 ©2019 Cengage Learning. All Rights Reserved. May not be scanned, copied or duplicated, or posted to a publicly accessible website, in whole or in part. ©SashkinShutterstock  8-2 Aggregate Demand (11 of 12) 8-2h Can a Change in the Money Supply Change Aggregate Demand? Most economists would say that it does, but they differ on how One way to explain the effect is this: – 1. A change in the money supply affects interest rates – 2. A change in interest rates changes consumption and investment, and – 3. A change in consumption and investment affects aggregate demand Therefore, a change in the money supply is a catalyst in a process that ends with a change in aggregate demand 22 ©2019 Cengage Learning. All Rights Reserved. May not be scanned, copied or duplicated, or posted to a publicly accessible website, in whole or in part. ©SashkinShutterstock  8-2 Aggregate Demand (12 of 12) 8-2i If Consumption Rises, Does Some Other Spending Component Have to Decline? Yes, if neither the money supply nor velocity changes No, if either the money supply or velocity rises Velocity: The average number of times a dollar is spent to buy final goods and services in a year Total spending in the economy can be a greater dollar amount than the money supply Total spending depends on the money supply and velocity 23 ©2019 Cengage Learning. All Rights Reserved. May not be scanned, copied or duplicated, or posted to a publicly accessible website, in whole or in part. ©SashkinShutterstock  8-3 Short-Run Aggregate Supply (1 of 2) Aggregate Supply: The quantity supplied of all goods and services (Real GDP) at different price levels, ceteris paribus 8-3a Short-Run Aggregate Supply Curve: What It Is and Why It Is Upward Sloping? Short-Run Aggregate Supply (SRAS) Curve: A curve that shows the quantity supplied of all goods and services (Real GDP) at different price levels, ceteris paribus Why is the SRAS curve (Exhibit 7) upward sloping? Economists have suggested a few explanations; we discuss two of them: – Sticky Wages – Worker Misperceptions 24 ©2019 Cengage Learning. All Rights Reserved. May not be scanned, copied or duplicated, or posted to a publicly accessible website, in whole or in part. ©SashkinShutterstock  EXHIBIT 7 The Short-Run Aggregate Supply Curve 25 ©2019 Cengage Learning. All Rights Reserved. May not be scanned, copied or duplicated, or posted to a publicly accessible website, in whole or in part. ©SashkinShutterstock  8-3 Short-Run Aggregate Supply (2 of 2) 8-3b What Puts the “Short-Run” in the SRAS Curve? Most macroeconomists believe the SRAS curve slopes upward because of sticky wages or worker misperceptions But these are likely to change over time; therefore, “short-run” 8-3c Changes in Short-Run Aggregate Supply: Shifts in the SRAS Curve The factors that can shift the SRAS curve are wage rates, prices of nonlabor inputs, productivity and supply shocks 8-3d Something More to Come: Peoples’ Expectations In a later chapter, we will begin to discuss how people’s expectations can affect the price level and Real GDP 26 ©2019 Cengage Learning. All Rights Reserved. May not be scanned, copied or duplicated, or posted to a publicly accessible website, in whole or in part. ©SashkinShutterstock  EXHIBIT 8 Wage Rates and a Shift in the Short-Run Aggregate Supply Curve 27 ©2019 Cengage Learning. All Rights Reserved. May not be scanned, copied or duplicated, or posted to a publicly accessible website, in whole or in part. ©SashkinShutterstock  EXHIBIT 9 Changes in Short-Run Aggregate Supply 28 ©2019 Cengage Learning. All Rights Reserved. May not be scanned, copied or duplicated, or posted to a publicly accessible website, in whole or in part. ©SashkinShutterstock  8-4 Putting AD and SRAS Together: Short-Run Equilibrium (1 of 3) Short-Run Equilibrium: The condition in the economy when the quantity demanded of Real GDP equals the (short-run) quantity supplied of Real GDP. This condition is met where the aggregate demand curve interacts the short-run aggregate supply curve 8-4a How Short-Run Equilibrium in the Economy is Achieved Exhibit 10 shows an aggregate demand (AD) curve and a short-run aggregate supply (SRAS) curve The quantity demanded of Real GDP and the quantity supplied of Real GDP are illustrated at 3 different price levels, P1, P2, and P3 A change in aggregate demand in short-run aggregate supply or both, will affect the price level and/or Real GDP (Exhibit 11) 29 ©2019 Cengage Learning. All Rights Reserved. May not be scanned, copied or duplicated, or posted to a publicly accessible website, in whole or in part. ©SashkinShutterstock  EXHIBIT 10 Short-Run Equilibrium 30 ©2019 Cengage Learning. All Rights Reserved. May not be scanned, copied or duplicated, or posted to a publicly accessible website, in whole or in part. ©SashkinShutterstock  EXHIBIT 11 Changes in Short-Run Equilibrium in the Economy 31 ©2019 Cengage Learning. All Rights Reserved. May not be scanned, copied or duplicated, or posted to a publicly accessible website, in whole or in part. ©SashkinShutterstock  8-4 Putting AD and SRAS Together: Short-Run Equilibrium (2 of 3) 8-4b Thinking in Terms of Short-Run Equilibrium Changes in the Economy Exhibit 12 shows us how changes in (AD) or (SRAS) can affect the economy and change P and Q Does the factor effect the AD curve or the SRAS curve? If neither, then there will be no change in either curve If the answer is the AD curve, then does it shift to the right or to the left? If the answer is the SRAS curve, does it shift to the right or to the left? 32 ©2019 Cengage Learning. All Rights Reserved. May not be scanned, copied or duplicated, or posted to a publicly accessible website, in whole or in part. ©SashkinShutterstock  EXHIBIT 12 How a Factor Affects the Price Level and Real GDP in the Short Run 33 ©2019 Cengage Learning. All Rights Reserved. May not be scanned, copied or duplicated, or posted to a publicly accessible website, in whole or in part. ©SashkinShutterstock  EXHIBIT 13 Changes in AD and SRAS (1 of 2) 34 ©2019 Cengage Learning. All Rights Reserved. May not be scanned, copied or duplicated, or posted to a publicly accessible website, in whole or in part. ©SashkinShutterstock  EXHIBIT 13 Changes in AD and SRAS (2 of 2) 35 ©2019 Cengage Learning. All Rights Reserved. May not be scanned, copied or duplicated, or posted to a publicly accessible website, in whole or in part. ©SashkinShutterstock  8-4 Putting AD and SRAS Together: Short-Run Equilibrium (3 of 3) 8-4c An Important Exhibit Exhibit 14 summarizes the material discussed so far Exhibit 14 tells us that the changes in AD and SRAS will change the price level and Real GDP in the short run; then it shows which factors actually change AD and which change SRAS While referring to Exhibit 14, consider what a fall in the interest rate will do to P and Q in the short run 36 ©2019 Cengage Learning. All Rights Reserved. May not be scanned, copied or duplicated, or posted to a publicly accessible website, in whole or in part. ©SashkinShutterstock  EXHIBIT 14 A Summary Exhibit of AD and SRAS 37 ©2019 Cengage Learning. All Rights Reserved. May not be scanned, copied or duplicated, or posted to a publicly accessible website, in whole or in part. ©SashkinShutterstock  8-5 Long-Run Aggregate Supply (1 of 4) Natural Real GDP: The Real GDP that is produced at the natural unemployment rate. Also, the Real GDP that is produced when the economy is in long-run equilibrium Long-Run Aggregate Supply (LRAS) Curve: A curve that represents the output the economy produces when wages and prices have adjusted to their final equilibrium levels and when workers do not have any relevant misperceptions. The LRAS curve is a vertical line at the level of Natural Real GDP Long-Run Equilibrium: The condition that exists in the economy when wages and prices have adjusted to their (final) equilibrium levels and when workers do not have any relevant misperceptions. Graphically, long-run equilibrium occurs at the intersection of the AD and LRAS curves 38 ©2019 Cengage Learning. All Rights Reserved. May not be scanned, copied or duplicated, or posted to a publicly accessible website, in whole or in part. ©SashkinShutterstock  8-5 Long-Run Aggregate Supply (2 of 4) 8-5a Going from the Short-Run to the Long Run Graphically, short-run equilibrium is at the intersection of the AD curve and the (upward-sloping) SRAS curve Economists give different reasons for an upward-sloping SRAS curve which have to do with sticky wages or worker misperceptions When either of these two conditions holds, short-run equilibrium identifies the Real GDP the economy produces But in time, wages become unstuck, and misperceptions turn into accurate perceptions In that event, the economy is said to be in the long run; the two conditions do not hold in the long run 39 ©2019 Cengage Learning. All Rights Reserved. May not be scanned, copied or duplicated, or posted to a publicly accessible website, in whole or in part. ©SashkinShutterstock  8-5 Long-Run Aggregate Supply (3 of 4) 8-5a Going from the Short-Run to the Long Run (cont) Will the level of Real GDP that the economy produces in the long run be the same as in the short run? Most economists say it will not; they argue that in the long run, the economy produces the full-employment Real GDP or the Natural Real GDP (QN) The long-run aggregate supply (LRAS) curve is portrayed as the vertical line in Exhibit 15 Long-run equilibrium identifies the level of Real GDP the economy produces (the intersection of the AD and LRAS curves) 40 ©2019 Cengage Learning. All Rights Reserved. May not be scanned, copied or duplicated, or posted to a publicly accessible website, in whole or in part. ©SashkinShutterstock  EXHIBIT 15 Long-Run Aggregate Supply (LRAS) Curve 41 ©2019 Cengage Learning. All Rights Reserved. May not be scanned, copied or duplicated, or posted to a publicly accessible website, in whole or in part. ©SashkinShutterstock  8-5 Long-Run Aggregate Supply (4 of 4) 8-5b Going from the Short-Run to the Long Run The two equilibrium states in an economy – short-run and long-run, are shown graphically in Exhibit 16 In both short-run and long-run equilibrium, the quantity supplied of Real GDP equals the quantity demanded; so what is the difference between short-run equilibrium and long-run equilibrium? In long-run equilibrium, the quantities supplied and demanded of Real GDP equal Natural Real GDP (Exhibit 16(b)) In short-run equilibrium, the quantities supplied and demanded of Real GDP are either more than or less than the Natural Real GDP 42 ©2019 Cengage Learning. All Rights Reserved. May not be scanned, copied or duplicated, or posted to a publicly accessible website, in whole or in part. ©SashkinShutterstock  EXHIBIT 16 Equilibrium States of the Economy 43 ©2019 Cengage Learning. All Rights Reserved. May not be scanned, copied or duplicated, or posted to a publicly accessible website, in whole or in part. ©SashkinShutterstock