Aggregate Demand and Supply - Macroeconomics - PDF

Topic 3.1 - Aggregate Demand (AD) ​ What is Aggregate Demand? ○​ Aggregate - added all together ○​ aggregate demand is all the goods and services (real GDP) that buyers are willing and able to purchase at different price levels ○​ If the price level...

Topic 3.1 - Aggregate Demand (AD) ​ What is Aggregate Demand? ○​ Aggregate - added all together ○​ aggregate demand is all the goods and services (real GDP) that buyers are willing and able to purchase at different price levels ○​ If the price level ​ Increases, the real GDP demanded decreases ​ Decreases, the real GDP demanded increases ​ Why is AD downward sloping ○​ The wealth effect ​ Higher price levels reduce the purchasing power of money. This decreases the quantity of expenditures ​ Lower price levels increase purchasing power and increase expenditures ​ AKA real balance effect ○​ Interest rate effect ​ When the price level increases, lenders need to charge higher interest rates to get a real return on their loans ​ Higher interest rates discourage consumer spending and business investment ○​ Foreign trade effect ​ When U.S. price level rises, foreign buyers purchase fewer U.S. goods and Americans buy more foreign goods ​ Exports fall and imports rise causing real GDP demanded to fall ​ Shifters of Aggregate Demand ○​ An increase in spending shifts AD right, and decrease in spending shifts it left ○​ Change in consumer spending ​ Increase in disposable income (higher incomes) ​ Consumer expectations (people fear a recession) ​ Household indebtedness (more consumer debt) ​ Taxes (decrease in income taxes) ○​ Change in investment spending ​ Real interest rates (price of borrowing money) ​ Future business expectations (high expectations) ​ Productivity and technology (new robots) ​ Business taxes (higher corporate taxes) ○​ Change in government spending ​ Government expenditures ○​ Change in net exports ​ Exchange rates (if the us dollar depreciates relative to euro) ​ National income compared abroad (if major importer has a recession)  Topic 3.2 - Multipliers ​ The Multiplier Effect ○​ An initial change in spending will set off a spending chain that is magnified in the economy ○​ The multiplier effect shows how spending is magnified in the economy ​ Effects of government spending ○​ If the government spends $5,000,000, will AD increase by the same amount ​ No, AD will increase even more as government spending becomes income for other consumers. Consumers will take that money and spend, thus increasing AD ○​ How much will AD increase ​ It depends on how much of the new income consumers save ​ If they save alot, spending and AD will increase less ​ If they save a little, spending and AD will increase more ​ Marginal Propensity to Consume (MPC) ○​ How much people consume rather than save when there is a change in disposable income ○​ It is always expressed as a fraction (decimal) ○​ MPC = change in consumption / change in disposable income ​ Marginal Propensity to Save (MPS) ○​ How much people save rather than consume when there is a change in disposable income ○​ It is also always expressed as a fraction (decimal) ○​ MPS = change in savings / change in disposable income ​ Calculating the Spending multiplier ○​ Spending multiplier ​ 1 / MPS ​ 1 / 1 - MPC ○​ Total change in GDP = multiplier * initial spending ​ What About Tax Cuts ○​ The multiplier effect also applies when the government cuts or increases taxes ○​ But, changing taxes has less of an impact than government spending ○​ Tax multiplier = MPC / MPS ​ Spending multiplier is stronger than the tax multiplier Topic 3.3- Short-Run Aggregate Supply (SRAS) ​ What is Aggregate Supply ○​ Aggregate supply is the amount of goods and services (real GDP) that firms will produce in an economy at different price levels. The supply for everything by all firms ○​ Short run aggregate supply ​ Wages and resource prices are sticky and WILL NOT change as price levels change ○​ Long run aggregate supply ​ Wages and resource prices are flexible and WILL change as price levels change ​ Shifters in Aggregate Supply ○​ Change in resources prices ​ Prices of domestic and imported resources ​ (Increase in price of canadian lumber) ​ (Decrease in price of chinese steel) ​ Supply shocks ​ (Negative supply shocks) ​ (Positive supply shocks) ​ Inflationary expectations ​ (If people expect higher prices in the future) ○​ Change in actions of the government ​ Taxes on producers ​ (Lower corporate taxes) ​ Subsidies for domestic producers ​ (Lower subsidies for domestic farmers) ​ Government regulations ​ (EPA inspections required to operate a farm ○​ Change in productivity ​ (Computer virus that destroys computers) ​ (The advent of a teleportation machine) Topic 3.4 - Long-Run Aggregate Supply (LRAS) ​ Example ○​ If a firm currently makes 100 units that are sold for $1 each, the only cost is $80 of labor. How much is profit. Profit = $100 - $80 = $20 ​ Shifts in LRAS  ○​ A permanent change in the production possibilities of the economy can shift LRAS ○​ The shifters of the LRAS are the same shifters of the PPC ​ Change in resource quantity or quality ​ Change in technology Topic 3.5 - Equilibrium in the Aggregate Demand - Aggregate Supply (AD - AS) Model ​ Notes were very notebook heavy Topic 3.6 - Changes in the AD-AS model in the Short Run ​ Causes of Inflation ○​ Demand-Pull inflation (AD increase) ○​ Cost-Push inflation (SRAS decrease) ​ Increase in GDP means increase in employment ​ Notes were very notebook heavy Topic 3.7 - Long-Run Self Adjustment ​ Long-Run Self Adjustment ○​ As prices go down, wages and cost decrease, so AS shifts right ○​ As prices go up, wages and cost increase, so AS shifts left ○​ When AD decreases/ shifts left, AS increases/ shifts right ○​ When AD increases/ shifts right, AS decreases/ shifts left ​ An increase in consumption or government spending does not cause economic growth, only investment causes growth since firms increase their capital stock ​ Notes were very notebook heavy Topic 3.8 - Fiscal Policy ​ The Role of Consumers in the Economy ○​ Consumption is the most important part of the economy ○​ Consumers will spend a certain amount no matter what regardless of their income. This is called autonomous consumption  ○​ This is usually to pay for necessities ○​ Consumer spending is made up of autonomous spending and disposable income (income after taxes) ○​ If incomes are less than autonomous spending, then there is dissaving (or negative supply shocks) ​ The government has two different tool boxes it can use ○​ Fiscal Policy - Action by Congress to stabilize the economy ○​ Monetary Policy - action by the Federal Reserve Bank to stabilize the economy ​ Discretionary vs Non-Discretionary ○​ Discretionary fiscal policy ​ Congress creates a new bill that is designed to change AD through government spending or taxation ​ One problem is lag times due to bureaucracy ​ It takes time for congress to act ○​ Non-discretionary fiscal policy ​ AKA: automatic stabilizers ​ Permanent spending or taxation laws enacted to work counter cyclically to stabilize the economy ​ When GDP goes down, government spending automatically increases and taxes automatically fall ​ Contractionary fiscal policy ○​ Laws that reduce inflation, decrease GDP (close and inflationary gap) ​ Decrease government spending ​ Increase taxes (decreasing disposable income) ​ Combinations of the two ​ Expansionary fiscal policy ○​ Laws that reduce unemployment and increase GDP (close a recessionary gap) ​ Increase government spending ​ Decrease taxes (increasing disposable income) ​ Timing and Fiscal Policy ○​ One of the problems of fiscal policy is that it takes time to go into effect ○​ Fiscal policy often has three time lags ​ Recognition lag - Congress ​ Administrative lag - ​ Operational lag - Topic 3.9 - Automatic Stabilizers ​ The U.S progressive income tax system acts counter cyclically to stabilize the economy  ○​ When DP is down, the tax burden on consumers is low, promoting consumption and increasing AD ○​ When GDP is up, more tax burden on consumers, discouraging consumption and decreasing AD. ​ Unemployment benefits and social service programs act counter cyclically to stabilize the economy ○​ When GDP is down, unemployment is higher and more benefits will be paid out. This helps to increase AD ○​ When GDP is up, unemployment is low and fewer benefits will be paid out, decreasing AD ​