Aggregate Demand and Aggregate Supply

29

McGraw-Hill/Irwin Copyright © 2012 by The McGraw-Hill Companies, Inc. All rights reserved.

AGENDA Mon 2/29

• Team Teaching: CH 29 (cont)

– P3: Connor, Kaleb, Jorge, Zach

– P5: Ms. K

• On Deck: CH 35 (Tues)

– P3: Grant, Hannah, Jason, Pedro

– P5: Ms. K (again)

• HW: Read pp 717-724 Q#1-2

LO1 29-2

QOD #18: 9-11 Effect

• In early 2001 investment spending sharply

declined in the United States. In the 2

months following the September 11, 2001,

attacks on the United States, consumption

also declined. Use AD-AS analysis to show

the two impacts on real GDP.

LO1 29-3

QOD #18: 9-11 Effect

• Both events would be represented by a

leftward shift in aggregate demand, and the

initial declines in spending would be multiplied.

This would cause a drop in real GDP and,

assuming flexible prices, a drop in the price

level. To the extent the decline in investment

spending affected productivity, it could have

either shifted AS left (if productivity dropped)

or slowed the rightward movement of AS that

occurred through much of the 1990s and into

the early 2000s. LO1 29-4

Aggregate Demand

• Real GDP desired at each price level

• Inverse relationship

Real balances effect-change in the price level. An

increase in the price level reduces the real value of

purchasing power which leads to less

CONSUMPTION.

Interest effect-if we assume the supply of money to

be fixed, higher prices lead to a shortfall of dollars.

Thus the demand for money rises, increasing the

interest rate. This leads to less C and Ig.

Foreign purchases effect-when the U.S. price level

rises, foreigners will buy____goods and Americans

will buy _____ foreign goods.

LO1 29-5

Aggregate Demand

Real domestic output, GDP

Pri

ce le

vel

AD

LO1

0

29-6

Changes in Aggregate Demand

Real domestic output, GDP

Pri

ce l

evel

AD1 AD3

AD2

LO1

0

29-7

Consumer Spending

• Consumer wealth-assets minus liabilities

•More wealth =________.

• Household borrowing

• Consumer expectations

• if we expect our future incomes to rise we

will spend more now.

• If we expect prices to rise in the future we

may also spend now.

• Personal taxes

LO1 29-8

Investment Spending

• Real interest rates-an increase raises borrowing costs.

• Expected returns

• Expectations about future business conditions

• If businesses think the economy will be better

in the future they will forecast higher rates of

return.

• Technology

• Degree of excess capacity-TOO much excess

capacity gives businesses little incentive to INVEST

more.

• Business taxes

LO1 29-9

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, less

unemployment LO1 29-10

Net Export Spending

• National income abroad

• Exchange rates

•Dollar depreciation-???

•Dollar appreciation-???

LO1 29-11

Aggregate Supply

• Total real output produced at each

price level

• Relationship depends on time horizon

• Immediate short run

•Short run-flat up to full emp. then

rises quickly. WHY?

• Long run- Why is it vertical?

LO2 29-12

AS: Immediate Short Run

Real domestic output, GDP

Pri

ce

level

ASISR

Qf

Immediate-short-run

aggregate supply

P1

0

LO2 29-13

Aggregate Supply: Short Run

Real domestic output, GDP

Pri

ce l

evel

0 Qf

AS

Aggregate supply

(short run)

LO2 29-14

Aggregate Supply: Long Run

Real domestic output, GDP

Pri

ce l

evel

ASLR

Qf 0

Long-run

aggregate

supply

LO2 29-15

Changes in Aggregate Supply

• Determinants of aggregate supply

•Shift factors

• Changes raise or lower per-unit

production costs

LO2 29-16

Changes in Aggregate Supply

Real domestic output, GDP

Pri

ce l

evel

AS1

AS3

AS2

0

LO2 29-17

Input Prices

• Domestic resource prices

• Labor

•Capital

• Land

• Prices of imported resources

• Imported oil

•Exchange rates

LO2 29-18

Productivity

• Real output per unit of input

• Increases in productivity reduce

costs

•Decreases in productivity increase

costs

LO2

Per-unit production cost = total input cost

total output

Productivity = total output

total inputs

29-19

Legal-Institutional Environment

• Legal changes alter per-unit costs of output

• Taxes and subsidies

• Extent of government regulation

•More could lead to less agg. supply,

however, if deregulation leads to unfair and

unsafe business practices, it could move

the other direction.

• Also, if agg. demand is strong enough,

would businesses really cut back?

LO2 29-20

Equilibrium

Real domestic output, GDP (billions of dollars)

Pri

ce l

evel

(in

dex n

um

bers

)

100

92

502 510 514

a b

AD

AS

Real Output

Demanded

(Billions)

Price Level

(Index Number)

Real Output

Supplied

(Billions)

$506 108 $513

508 104 512

510 100 510

512 96 507

514 92 502

0

LO3 29-21

Increases in AD: Demand-Pull Inflation

Real domestic output, GDP

Pri

ce l

evel

AD1

AS

P1

P2

Q2 Q1 Qf

AD2

0

LO4 29-22

Why?

• Firms boost investment spending because

they anticipate higher future profits from

investments in new capital.

• Government increases spending for such

programs as national defense.

Decreases in AD: Recession

Real domestic output, GDP

Pri

ce

le

ve

l

AD1

AS

P1

P2

Q1 Q2 Qf

AD2

c

a b

0

LO4 29-24

Prices?

• Sticky prices

• Costs do not necessarily change-menu

costs, minimum wage, wage contracts

• Morale, productivity-wage inflexibility

• Price wars

Decreases in AS: Cost-Push Inflation

Real domestic output, GDP

Pri

ce l

evel

AD

AS1

P1

P2

Q1 Qf

AS2

a

b

0

LO4 29-26

Increases in AS: Full-Employment

Real domestic output, GDP

Pri

ce

le

ve

l

AD1

AS2

P1

P2

Q2 Q1

AS1

b

AD2

c

P3

Q3

a

0

LO4 29-27