Aggerate Demand and Supply

AEEEK0014 PRINCIPLES OF ECONOMICS GROUP D ROSLAN BIN ABDUL HAKIM Professor of Economics School of Economics, Finance and Banking UNIVERSITI UTARA MALAYSIA  Survey of Economics....

AEEEK0014 PRINCIPLES OF ECONOMICS GROUP D ROSLAN BIN ABDUL HAKIM Professor of Economics School of Economics, Finance and Banking UNIVERSITI UTARA MALAYSIA  Survey of Economics. 11e Chapter 15: Aggregate Demand and Supply Tucker, Survey of Economics, 11th Edition. © 2023 Cengage. All Rights Reserved. May not be scanned, copied or duplicated, or posted to a publicly accessible website, in whole or in part. 2 Chapter Objectives By the end of this chapter, you should be able to: 1. Explain why the aggregate demand curve is downward sloping and what can cause it to shift. 2. Discuss the three ranges of the aggregate supply curve and what can cause the aggregate supply curve to shift. 3. Predict changes in real GDP, employment, and the price level given shifts in aggregate demand and supply curves. 4. Contrast demand-pull and cost-push inflation in terms of the aggregate demand and supply model.  Unit 1 The Aggregate Demand Curve Tucker, Survey of Economics, 11th Edition. © 2023 Cengage. All Rights Reserved. May not be scanned, copied or duplicated, or posted to a publicly accessible website, in whole or in part. 4 What is the aggregate demand curve (AD)? The curve that shows the level of real GDP purchased by households, businesses, government, and foreigners (net exports) at different possible price levels during a time period, ceteris paribus. How does the horizontal axis in the market supply and demand model and aggregate demand and supply model differ? While the horizontal axis in the market supply and demand model for a specific product measures physical units, such as bushels of wheat, the horizontal axis in the aggregate demand and supply model measures the value of final goods and services included in real GDP. How does the vertical axis in the market supply and demand model and aggregate demand and supply model differ? The vertical axis in the aggregate demand and supply model is an index of the overall price level measured by the consumer price index (CPI), rather than the price per bushel of wheat.  How does the aggregate demand curve and a specific market demand curve differ? As we move along a market demand curve, the price of related goods is assumed to be constant. But when we deal with changes in the general or average price level in an economy, this assumption is meaningless because we are using a market basket measure for ALL goods and services.  What conclusion can we make regarding the aggregate demand curve? The aggregate demand curve and a specific market demand curve are not the same concept. Exhibit 1: The Aggregate Demand Curve Knowledge Check Activity #1 An increase in the price level will a. shift the Aggregate Demand (AD) curve to the right. b. shift the Aggregate Demand (AD) curve to the left. c. cause movement down along the Aggregate Demand (AD) curve. d. decrease the quantity of real GDP demanded. ANSWER: Knowledge Check Activity #1 An increase in the price level will a. shift the Aggregate Demand (AD) curve to the right. b. shift the Aggregate Demand (AD) curve to the left. c. cause movement down along the Aggregate Demand (AD) curve. d. decrease the quantity of real GDP demanded.  Unit 2 Reasons for the Aggregate Demand Curve’s Shape Tucker, Survey of Economics, 11th Edition. © 2023 Cengage. All Rights Reserved. May not be scanned, copied or duplicated, or posted to a publicly accessible website, in whole or in part. 13 What are the reasons for the aggregate demand curve’s downward slope? Real balances effect Interest-rate effect Net exports effect  What conclusion can we make regarding the real value of money? Consumers spend more on goods and services when lower prices make their dollars more valuable. Therefore, the real value of money is measured by the quantity of goods and services each dollar buys. What is the real balances effect? The impact on total spending (and therefore real GDP) caused by the inverse relationship between the price level and the real value of financial assets with fixed nominal value. What is the interest-rate effect? The impact on total spending (and therefore real GDP) caused by the direct relationship between the price level and the interest rate. What is the net exports effect? The impact on total spending (and therefore real GDP) caused by the inverse relationship between the price level and the net exports of an economy. Exhibit 2: Why the Aggregate Demand Curve Is Downward Sloping Effect Causation Chain Real balances effect Price level decreases → Purchasing power rises → Wealth rises → Consumers buy more goods → The quantity of real GDP demanded increases Interest-rate effect Price level decreases → Purchasing power rises → Demand for fixed supply of credit falls → Interest rates fall → Businesses and households borrow and buy more goods → The quantity of real GDP demanded increases Net exports effect Price level decreases → U.S. goods become less expensive than foreign goods → Americans and foreigners buy more U.S. goods → Exports rise and imports fall → The quantity of real GDP demanded increases Knowledge Check Activity #2 When consumers spend more on goods and services when prices fall because the purchasing power of their money increases, this is known as the a. interest rate effect. b. net exports effect. c. real balances effect. d. money multiplier effect. ANSWER: Knowledge Check Activity #2 When consumers spend more on goods and services when prices fall because the purchasing power of their money increases, this is known as the a. interest rate effect. b. net exports effect. c. real balances effect. d. money multiplier effect.  Unit 3 Nonprice-Level Determinants of Aggregate Demand Tucker, Survey of Economics, 11th Edition. © 2023 Cengage. All Rights Reserved. May not be scanned, copied or duplicated, or posted to a publicly accessible website, in whole or in part. 22 What are the nonprice- level determinants of aggregate demand? Consumption (C) Investment (I) Government spending (G) Net exports (X – M) What conclusion can we make regarding the nonprice-level determinants of aggregate demand? Any change in the individual components of aggregate expenditures shifts the aggregate demand curve. What increases aggregate demand and shifts the aggregate demand curve to the right? Anything that increases aggregate expenditures [C, I, G, (X - M)] shifts the AD curve rightward. What decreases aggregate demand and shifts the aggregate demand curve to the left? Anything that decreases aggregate expenditures [C, I, G, (X - M )] shifts the AD curve leftward. Exhibit 3: A Shift in the Aggregate Demand Curve Knowledge Check Activity #3 Which of the following could cause a rightward shift of the aggregate demand (AD) curve? a. A lower price level b. More pessimistic expectations about the future state of the economy c. A cut in personal and business income taxes d. An increase in imports ANSWER: Knowledge Check Activity #3 Which of the following could cause a rightward shift of the aggregate demand (AD) curve? a. A lower price level b. More pessimistic expectations about the future state of the economy c. A cut in personal and business income taxes d. An increase in imports  Unit 4 The Aggregate Supply Curve Tucker, Survey of Economics, 11th Edition. © 2023 Cengage. All Rights Reserved. May not be scanned, copied or duplicated, or posted to a publicly accessible website, in whole or in part. 30 What is the aggregate supply curve (AS)? The curve that shows the level of real GDP produced at different possible price levels during a time period, ceteris paribus. What are the two opposing views of aggregate supply? 1. The Keynesian horizontal aggregate supply curve 2. The classical vertical aggregate supply curve What do the Keynesians believe? Unless an economy trapped in a depression or severe recession is rescued by an increase in aggregate demand, full employment will not be achieved. Thus, government must intervene and actively manage demand to avoid a depression or recession. What do Keynesians assume about product prices and wages? Keynesians assume that product prices and wages are fixed. Exhibit 4: The Keynesian Horizontal Aggregate Supply Curve What conclusion can we make regarding the Keynesian view of aggregate supply? When the aggregate supply curve is horizontal and an economy is in recession below full employment, the only effects of an increase in aggregate demand are increases in real GDP and employment, while the price level does not change. Stated simply, the Keynesian view is that “demand creates its own supply.” What do the classical economists believe? The classical economists believe that recessions naturally cure themselves because the capitalistic price system automatically restores full employment and that government intervention is not needed.  What do classical economists assume about product prices and wages? The classical economists believe that prices and wages are completely flexible. Exhibit 5: The Classical Vertical Aggregate Supply Curve What conclusion can we make regarding the classical view of aggregate supply? When the aggregate supply curve is vertical at the full- employment GDP, the only effect over time of a change in aggregate demand is a change in the price level. Stated simply, the classical view is that “supply creates its own demand.” What conclusion can we make regarding the two opposing views of aggregate supply for an economy in recession? Keynesian theory rejects classical theory for an economy in recession because Keynesians argue that during a recession, prices and wages do not adjust downward to restore an economy to full-employment real GDP. What are the three ranges of the aggregate supply curve? 1. Keynesian range 2. Intermediate range 3. Classical range Exhibit 6: The Three Ranges of the Aggregate Supply Curve What is the Keynesian range? The horizontal segment of the aggregate supply curve, which represents an economy in a severe recession. What is the intermediate range? The rising segment of the aggregate supply curve, which represents an economy as it approaches full-employment output.  What is the classical range? The vertical segment of the aggregate supply curve, which represents an economy at full-employment output. Discussion Activity #1 Which range of the aggregate supply (AS) curve do you think we are currently in? Why?  Unit 5 Changes in AD-AS Macroeconomic Equilibrium Tucker, Survey of Economics, 11th Edition. © 2023 Cengage. All Rights Reserved. May not be scanned, copied or duplicated, or posted to a publicly accessible website, in whole or in part. 48  Where does macroeconomic equilibrium occur? Where the aggregate demand curve, AD, and the aggregate supply curve, AS, intersect. Exhibit 7: The Aggregate Demand and Aggregate Supply Model  What conclusion can we make regarding macroeconomic equilibrium? At macroeconomic equilibrium, sellers neither overestimate nor underestimate the real GDP demanded at the prevailing price level. Exhibit 8: Effects of Increases in Aggregate Demand What conclusion can we make regarding the effect of an increase in aggregate demand in the Keynesian range? As aggregate demand increases in the Keynesian range, the price level remains constant as real GDP expands. What conclusion can we make regarding the effect of an increase in aggregate demand in the intermediate range? In the intermediate range, increases in aggregate demand increase both the price level and the real GDP level. What conclusion can we make regarding the effect of an increase in aggregate demand in the classical range? Once the economy reaches full-employment output in the classical range, additional increases in aggregate demand merely cause inflation, rather than more real GDP. Exhibit 9: Effect of Decreases in Aggregate Demand During 2008-2009 of the Great Recession Knowledge Check Activity #4 If aggregate demand increases and real GDP expands, and the price level rises as well, then along which range of the aggregate supply curve are we operating? a. The Keynesian range b. The intermediate range c. The classical range d. The vertical range ANSWER: Knowledge Check Activity #4 If aggregate demand increases and real GDP expands, and the price level rises as well, then along which range of the aggregate supply curve are we operating? a. The Keynesian range b. The intermediate range c. The classical range d. The vertical range  Unit 6 Nonprice-Level Determinants of Aggregate Supply Tucker, Survey of Economics, 11th Edition. © 2023 Cengage. All Rights Reserved. May not be scanned, copied or duplicated, or posted to a publicly accessible website, in whole or in part. 59 What are the nonprice- level determinants of aggregate supply? Resource prices (domestic and imported) Technological change Taxes Subsidies Regulations What is the relationship between the nonprice-level determinants of aggregate supply and production costs? Each of these factors affects production costs. At a given price level, the profit businesses make at any level of real GDP depends on production costs. If costs change, firms respond by changing their output. What conclusion can we make regarding production costs and the aggregate supply curve? Lower production costs shift the aggregate supply curve rightward, indicating greater real GDP is supplied at any price level. Higher production costs shift the aggregate supply curve leftward, meaning less GDP is supplied at any price level. What are some examples of conditions that lower production costs and cause a rightward shift of the aggregate supply curve? Lower oil prices Greater entrepreneurship Lower taxes Reduced government regulation Exhibit 10: A Rightward Shift in the Aggregate Supply Curve What are some examples of conditions that increase production costs and cause a leftward shift of the aggregate supply curve? Larger-than-expected wage increases Higher taxes to protect the environment Greater government regulation Higher health insurance premiums Exhibit 11: Summary of the Nonprice–Level Determinants of Aggregate Demand and Aggregate Supply That Shift AD and AS Nonprice-Level Determinants of Nonprice-Level Determinants Aggregate Demand (total spending) of Aggregate Supply 1. Consumption (C) 1. Resource prices (domestic and imported) 2. Investment (I) 2. Taxes 3. Government spending (G) 3. Technological change 4. Net exports (X - M) 4. Subsidies 5. Regulation Knowledge Check Activity #5 Which of the following could cause a rightward shift of the aggregate supply (AS) curve? a. A lower price level b. Lower costs of raw materials c. An increase in government spending d. An increase in exports ANSWER: Knowledge Check Activity #5 Which of the following could cause a rightward shift of the aggregate supply (AS) curve? a. A lower price level b. Lower costs of raw materials c. An increase in government spending d. An increase in exports Exhibit 12: A Rightward Shift in the Aggregate Demand and Supply Curves  Unit 7 Cost-Push and Demand-Pull Inflation Revisited Tucker, Survey of Economics, 11th Edition. © 2023 Cengage. All Rights Reserved. May not be scanned, copied or duplicated, or posted to a publicly accessible website, in whole or in part. 70 What are the two types of inflation? 1. Cost-push inflation 2. Demand-pull inflation What is stagflation? The condition that occurs when an economy experiences the twin maladies of high unemployment and rapid inflation simultaneously. What is cost-push inflation? An increase in the general price level resulting from an increase in the cost of production that causes the aggregate supply curve to shift leftward. What is demand-pull inflation? A rise in the general price level resulting from an excess of total spending (demand) caused by a rightward shift in the aggregate demand curve. Exhibit 13: Cost-Push and Demand-Pull Inflation What conclusion can we make regarding the effects of shifts in the aggregate demand and supply curves on the economy? The business cycle is a result of shifts in the aggregate demand and aggregate supply curves. A leftward shift in the aggregate demand curve, for example, can cause a recession. Whereas a rightward shift of the aggregate demand curve can cause real GDP and employment to rise, and the economy recovers. A leftward shift in the aggregate supply curve can cause a downswing, and a rightward shift will cause an upswing. Knowledge Check Activity #6 Suppose there is a significant increase in government spending to address a recession. This will cause a. a leftward shift of the AS curve, creating some cost-push inflation. b. a rightward shift of the AS curve, creating some demand-pull inflation. c. a leftward shift of the AD curve, creating some cost-push inflation. d. a rightward shift of the AD curve, creating some demand-pull inflation. ANSWER: Knowledge Check Activity #6 Suppose there is a significant increase in government spending to address a recession. This will cause a. a leftward shift of the AS curve, creating some cost-push inflation. b. a rightward shift of the AS curve, creating some demand-pull inflation. c. a leftward shift of the AD curve, creating some cost-push inflation. d. a rightward shift of the AD curve, creating some demand-pull inflation. Self Assessment What concepts introduced in this chapter did you find difficult and thus, need to review? What do you know now that you did not know before? How could you apply what you have learned in this chapter to help you in your personal or professional life? Summary Now that the lesson has ended, you should be able to: 1. Explain why the aggregate demand curve is downward sloping and what can cause it to shift. 2. Discuss the three ranges of the aggregate supply curve and what can cause the aggregate supply curve to shift. 3. Predict changes in real GDP, employment, and the price level given shifts in aggregate demand and supply curves. 4. Contrast demand-pull and cost-push inflation in terms of the aggregate demand and supply model.