Chapter 26: Aggregate Output, Price Level, and Interest Rates PDF

Chapter 26: Aggregate Output, Price Level, and Interest Rates ============================================================= Key Topics ---------- 1\. Aggregate Supply (AS) 2\. Aggregate Demand (AD) 3\. IS-Fed Rule Model 4\. Long Run Aggregate Supply (LRAS) 1. Aggregate Supply (AS) ------------...

Chapter 26: Aggregate Output, Price Level, and Interest Rates ============================================================= Key Topics ---------- 1\. Aggregate Supply (AS) 2\. Aggregate Demand (AD) 3\. IS-Fed Rule Model 4\. Long Run Aggregate Supply (LRAS) 1. Aggregate Supply (AS) ------------------------ \*\*Definition\*\*: Total production of goods and services in an economy. \*\*AS Curve\*\*: Shows the relationship between the price level and the quantity of output (Y). \- \*\*Shape\*\*: \- \*\*Flat (elastic)\*\*: Economy has unused resources. \- \*\*Steep (inelastic)\*\*: Economy near full capacity. \- \*\*Short-Run AS\*\*: Upward sloping due to sticky wages. \- \*\*Long-Run AS\*\*: Vertical because wage adjustments ensure output remains at potential GDP (Y₀). \*\*Key Points\*\*: \- In the short run, higher prices encourage more production since wages adjust slowly. \- In the long run, wage adjustments balance increased revenues with higher costs, keeping output fixed at Y₀. \*\*Formulas\*\*: \- \*\*Short-Run AS Movement\*\*: \- Increase in price → Increase in output. \- \*\*Shift in AS\*\*: Caused by changes in input costs (e.g., oil prices). 2. Aggregate Demand (AD) ------------------------ \*\*Definition\*\*: Total demand for goods and services in an economy. \- \*\*AD Curve\*\*: Downward sloping because: \- Higher prices reduce purchasing power and demand. \- Higher prices increase interest rates, decreasing investment (I). \*\*Factors Shifting AD\*\*: \- \*\*Increase in AD\*\*: \- Higher consumption (C↑), investment (I↑), or government spending (G↑). \- Lower taxes (T↓). \- \*\*Decrease in AD\*\*: \- Opposite of the above factors. \- Decline in consumer confidence (Z↓). 3. IS-Fed Rule Model -------------------- \*\*Definition\*\*: Relationship between interest rates (R) and aggregate output (Y). \- \*\*IS Curve\*\*: Downward sloping. \- \*\*Reason\*\*: Higher R → Lower investment (I↓) → Lower Y. \- \*\*Shifts\*\*: Caused by changes in G, C, I, or T. \- \*\*Fed Rule\*\*: Central bank\'s response to economic changes. \- \*\*Formula\*\*: R = αY + βP + γZ \- R: Interest rate \- Y: Output \- P: Price level \- Z: Other factors (e.g., consumer confidence). \*\*Key Relationships\*\*: \- \*\*Higher R\*\*: \- Decreases I → Decreases AD → Decreases Y. \- \*\*Fed Rule\*\*: \- Central bank adjusts R to control inflation or stabilize Y. 4. Long-Run Aggregate Supply (LRAS) ----------------------------------- \*\*Definition\*\*: Maximum sustainable output (Y₀) regardless of price level. \- \*\*Shape\*\*: Vertical. \- \*\*Shifts\*\*: \- Increase in resources or productivity → Shift right. \- Resource depletion → Shift left. \*\*Adjustments\*\*: \- \*\*Short-Run to Long-Run\*\*: \- In the short run, shocks to AD affect output (Y). \- In the long run, wage adjustments return Y to Y₀. Summary of Formulas ------------------- 1\. \*\*Aggregate Supply\*\*: \- Short-run: Prices ↑ → Output ↑. \- Long-run: Prices and wages adjust → Output = Y₀. 2\. \*\*Aggregate Demand\*\*: \- AD = C + I + G. \- Higher prices → Lower AD. 3\. \*\*IS-Fed Rule\*\*: \- IS Curve: Higher R → Lower Y. \- Fed Rule: R = αY + βP + γZ. 4\. \*\*Long-Run Adjustments\*\*: \- Short-run shocks lead to temporary output changes. \- In the long run, economy returns to Y₀. Graphical Summary ----------------- \- \*\*AS-AD Model\*\*: \- Intersection determines price level and output. \- Shifts in AS/AD indicate changes in economic conditions. \- \*\*IS-Fed Rule\*\*: \- Shows relationship between R and Y. Conclusion ---------- Understanding these models helps explain how economies balance output, prices, and interest rates in the short and long run.