Aggregate Demand and Aggregate Supply Model PDF

32 Aggregate Demand and Aggregate Supply McGraw-Hill/Irwin Copyright © 2012 by The McGraw-Hill Companies, Inc. All rights reserved.  Aggregate Demand Real GDP desired at each price level Inverse relationship...

32 Aggregate Demand and Aggregate Supply McGraw-Hill/Irwin Copyright © 2012 by The McGraw-Hill Companies, Inc. All rights reserved.  Aggregate Demand Real GDP desired at each price level Inverse relationship Real balances effect Interest effect Foreign purchases effect LO1  Aggregate Demand Price level AD 0 Real domestic output, GDP LO1  Changes in Aggregate Demand Determinants of aggregate demand Shift factors affecting C, I, G, Xn 2 components involved Change in one of the determinants Multiplier effect LO1  Changes in Aggregate Demand Price level AD2 AD1 AD3 0 Real domestic output, GDP LO1  Consumer Spending Consumer wealth Household borrowing Consumer expectations Personal taxes LO1  Investment Spending Real interest rates Expected returns Expectations about future business conditions Technology Degree of excess capacity Business taxes LO1  Government Spending Government spending increases Aggregate demand increases (as long as interest rates and tax rates do not change) More transportation projects Government spending decreases Aggregate demand decreases Less military spending LO1  Net Export Spending National income abroad Exchange rates Real depreciation Real appreciation LO1  Aggregate Supply Total real output produced at each price level Relationship depends on time horizon Immediate short run- both input and output prices are fixed Short run- input prices are fixed or highly inflexible, while output prices are flexible Long run- both input and output prices are flexible LO2  AS: Immediate Short Run Immediate-short-run aggregate supply Price level P1 ASISR 0 Qf Real domestic output, GDP LO2  Aggregate Supply: Short Run AS Aggregate supply (short run) Price level 0 Qf Real domestic output, GDP LO2  Aggregate Supply: Long Run ASLR Price level Long-run aggregate supply 0 Qf Real domestic output, GDP LO2  Changes in Aggregate Supply Determinants of aggregate supply Shift factors Collectively position the AS curve Changes raise or lower per-unit production costs LO2  Changes in Aggregate Supply AS3 AS1 AS2 Price level 0 Real domestic output, GDP LO2  Input Prices Domestic resource prices Labor Capital Land Prices of imported resources Imported oil Exchange rates LO2  Productivity Real output per unit of input Increases in productivity reduce costs Decreases in productivity increase costs total output Productivity = total inputs total input cost Per-unit production cost = total output LO2  Legal-Institutional Environment Legal changes alter per-unit costs of output Taxes and subsidies Extent of government regulation LO2  Equilibrium Real Output Real Output AS Demanded Price Level Supplied (Billions) (Index Number) (Billions) Price level (index numbers) $506 108 $513 508 104 512 510 100 510 100 a 512 96 507 b 92 514 92 502 AD 0 502 510 514 Real domestic output, GDP (billions of dollars) LO3  AD Increases: Demand-Pull Inflation AS Price level P2 P1 AD2 AD1 0 Qf Q1 Q2 Real domestic output, GDP LO4  Decreases in AD: Recession AS Price level b P1 a P2 c AD1 AD2 0 Q1 Q2 Qf Real domestic output, GDP LO4  Decreases in AD: Recession Prices are downwardly inflexible Fear of price wars Menu costs Wage contracts Efficiency wages Minimum wage law LO4  Decreases in AS: Cost-Push Inflation AS2 AS1 Price level b P2 a P1 AD 0 Q1 Qf Real domestic output, GDP LO4  Increases in AS: Full-Employment AS1 AS2 P3 b Price level P2 c P1 a AD2 AD1 0 Q1 Q2 Q3 Real domestic output, GDP LO4 Impact of Oil Prices Diminished? 1970’s Reduced AS and negative GDP gap Cost-push inflation Rising unemployment 2000’s Core inflation steady Use 50% less oil and gas today