© 2005 Thomson C hapter 4 Aggregate Demand and Aggregate Supply.
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Transcript of © 2005 Thomson C hapter 4 Aggregate Demand and Aggregate Supply.
© 2005 Thomson
CChapter 4hapter 4
Aggregate Demand Aggregate Demand and Aggregate and Aggregate
SupplySupply
© 2005 Thomson
2Gottheil - Principles of Economics, 4e
Economic PrinciplesEconomic PrinciplesThe phases of the business cycle
Gross Domestic Product (GDP)
The CPI and GDP deflator
Nominal and real GDP
Aggregate demand and aggregate supply
Macroeconomic equilibrium
Demand-pull and cost-push inflation
© 2005 Thomson
3Gottheil - Principles of Economics, 4e
Why Recession? Why Why Recession? Why Prosperity?Prosperity?• Recession
•A phase in the business cycle in which the decline in the economy’s real GDP persists for at least a half-year. A recession is marked by relatively high unemployment.
•Depression
•Severe recession.
© 2005 Thomson
4Gottheil - Principles of Economics, 4e
Why Recession? Why Why Recession? Why Prosperity?Prosperity?
Prosperity
• A phase in the business cycle marked by a relatively high level of real GDP, full employment, and inflation.
© 2005 Thomson
5Gottheil - Principles of Economics, 4e
Why Recession? Why Why Recession? Why Prosperity?Prosperity?
Business cycle
• Alternating periods of growth and decline in an economy’s GDP.
•No two business cycles are identical. The number of months in any given phase of the cycle varies from cycle to cycle.
© 2005 Thomson
6Gottheil - Principles of Economics, 4e
Why Recession? Why Why Recession? Why Prosperity?Prosperity?
Trough
• The bottom of a business cycle.
• This is the time period when the economy’s unemployment rate is greatest and output declines to the cycle’s minimum level.
© 2005 Thomson
7Gottheil - Principles of Economics, 4e
Why Recession? Why Why Recession? Why Prosperity?Prosperity?
Recovery
• A phase in the business cycle, following a recession, in which real GDP increases and unemployment declines.
© 2005 Thomson
8Gottheil - Principles of Economics, 4e
Why Recession? Why Why Recession? Why Prosperity?Prosperity?
Peak
• The top of a business cycle.
• This is the time period when output reaches its maximum level, the labor force is fully employed, and increasing pressure on prices is likely to generate inflation.
© 2005 Thomson
9Gottheil - Principles of Economics, 4e
Why Recession? Why Why Recession? Why Prosperity?Prosperity?
Downturn
• A phase in the business cycle in which real GDP declines, inflation moderates, and unemployment emerges.
© 2005 Thomson
10Gottheil - Principles of
Economics, 4e
EXHIBIT 1 THE BUSINESS CYCLE
© 2005 Thomson
11Gottheil - Principles of
Economics, 4e
Measuring the National Measuring the National EconomyEconomy
• Total value of all final goods and services, measured in current market prices, produced in the economy during a year.
• Final goods and services refers to everything produced that is not itself used to produce other goods and services
•During a given year refers to a specific calendar year.
•Produced in the economy refers to any good or service produced in the United States, regardless of whether a US-owned or a foreign-owned company is producing.
Gross Domestic Product (GDP)
© 2005 Thomson
12Gottheil - Principles of
Economics, 4e
Measuring the Measuring the National EconomyNational Economy
To compare GDP across years, we must devise some way of eliminating the effect of inflation.
© 2005 Thomson
13Gottheil - Principles of
Economics, 4e
Measuring the National Measuring the National EconomyEconomy
Nominal GDP• GDP measured in terms of current market prices—that is, the price level at the time of measurement. (It is not adjusted for inflation.)
•Real GDP
•GDP adjusted for changes in the price level.
© 2005 Thomson
14Gottheil - Principles of
Economics, 4e
Measuring the Measuring the National EconomyNational Economy
• Price indices are designed to remove the effect of price changes.
• The consumer price index and the GDP deflator are the two indices most commonly used.
© 2005 Thomson
15Gottheil - Principles of
Economics, 4e
Measuring the Measuring the National EconomyNational Economy
Consumer Price Index (CPI)
• A measure comparing the prices of consumer goods and services that a household typically purchases to the prices of those goods and services purchased in a base year.
© 2005 Thomson
16Gottheil - Principles of
Economics, 4e
Measuring the Measuring the National EconomyNational Economy
Price level
• A measure of prices in one year expressed in relation to prices in a base year.
© 2005 Thomson
17Gottheil - Principles of
Economics, 4e
Measuring the Measuring the National EconomyNational Economy
Example: Suppose in 1998 (the base year) a basket of goods including such things as food, clothing, and fuel cost $350. The $350 converts to a price level index of 100, P = 100.
Suppose in the next year, 1999, the same basket of goods cost $385.
The 1999 CPI, measured against the 1998 base year of 100, is 110. P = ($385/$350) × 100 = 110.
© 2005 Thomson
18Gottheil - Principles of
Economics, 4e
Measuring the Measuring the National EconomyNational Economy
Example: A 1999 P = 110 indicates that from 1998 to 1999 the cost of goods and services that consumers typically buy increased by 10 percent.
© 2005 Thomson
19Gottheil - Principles of
Economics, 4e
Measuring the Measuring the National EconomyNational Economy
GDP deflator• A measure comparing the prices of all goods and services produced in the economy during a given year to the prices of those goods and services purchased in a base year.
•This price index includes not only consumer goods and services, but also producer goods, investment goods, exports and imports, and goods and services purchased by government.
© 2005 Thomson
20Gottheil - Principles of
Economics, 4e
EXHIBIT 2 CONVERTING NOMINAL GDP TO REAL GDP: 1995–2002 ($ BILLIONS, 1996 = 100)
Source: U.S. Department of Commerce, Bureau of Economic Analysis.
© 2005 Thomson
21Gottheil - Principles of
Economics, 4e
Deriving Equilibrium GDP in Deriving Equilibrium GDP in the Aggregate Demand and the Aggregate Demand and
Supply ModelSupply ModelThe aggregate demand and aggregate supply model is one model used to explain how GDP is determined.
© 2005 Thomson
22Gottheil - Principles of
Economics, 4e
Deriving Equilibrium GDP in Deriving Equilibrium GDP in the Aggregate Demand and the Aggregate Demand and
Supply ModelSupply ModelAggregate supply
• The total quantity of goods and services that firms in the economy are willing to supply at varying price levels.
© 2005 Thomson
23Gottheil - Principles of
Economics, 4e
Deriving Equilibrium GDP in Deriving Equilibrium GDP in the Aggregate Demand and the Aggregate Demand and
Supply ModelSupply ModelThere are three distinct segments of the aggregate supply curve:1. Horizontal segment. Real GDP increases without
affecting the economy’s price level.
2. Upward-sloping segment. A positive relationship between real GDP and price level.
3. Vertical segment. All resources are fully employed, so that real GDP cannot increase.
© 2005 Thomson
24Gottheil - Principles of
Economics, 4e
Deriving Equilibrium GDP in Deriving Equilibrium GDP in the Aggregate Demand and the Aggregate Demand and
Supply ModelSupply ModelAggregate demand• The total quantity of goods and services demanded by households, firms, foreigners, and government at varying price levels.•Increases in the price level affect people’s real wealth, their lending and borrowing activity, and the nation’s trade with other nations.
•The quantity of goods and services demanded in the economy declines when price levels increase.
© 2005 Thomson
25Gottheil - Principles of
Economics, 4e
EXHIBIT 3 AGGREGATE SUPPLY AND AGGREGATE DEMAND
© 2005 Thomson
26Gottheil - Principles of
Economics, 4e
Deriving Equilibrium GDP in Deriving Equilibrium GDP in the Aggregate Demand and the Aggregate Demand and
Supply ModelSupply Model• The aggregate demand curve shifts when there is a change in the quantity of goods and services demanded at a particular price level.
• Government spending, income levels, and expectations about the future are all factors that can cause the curve to shift.
© 2005 Thomson
27Gottheil - Principles of
Economics, 4e
Deriving Equilibrium GDP in Deriving Equilibrium GDP in the Aggregate Demand and the Aggregate Demand and
Supply ModelSupply ModelThe aggregate supply curve shifts due to factors such as changes in resource availability and resource prices.
© 2005 Thomson
28Gottheil - Principles of
Economics, 4e
EXHIBIT 4 SHIFTS IN AGGREGATE DEMAND AND AGGREGATE SUPPLY
© 2005 Thomson
29Gottheil - Principles of
Economics, 4e
Exhibit 4: Shifts in Exhibit 4: Shifts in Aggregate Demand and Aggregate Demand and
Aggregate SupplyAggregate SupplyWhat might cause the aggregate demand curve in panel a of Exhibit 4 to shift to the right?• Increases in government spending, increases in incomes, and optimistic expectations could all cause the aggregate demand curve to shift to the right.
© 2005 Thomson
30Gottheil - Principles of
Economics, 4e
Macroeconomic Macroeconomic EquilibriumEquilibrium
Macroequilibrium• The level of real GDP and the price level that equate the aggregate quantity demanded and the aggregate quantity supplied.
© 2005 Thomson
31Gottheil - Principles of
Economics, 4e
Exhibit 5: Achieving Exhibit 5: Achieving Macroeconomic Macroeconomic
EquilibriumEquilibrium1. At what price level and real GDP is macroequilibrium achieved in Exhibit 5?• Macroequilibrium is achieved at P = 101.95 and real GDP = $8.1595 trillion.
© 2005 Thomson
32Gottheil - Principles of
Economics, 4e
Exhibit 5: Achieving Exhibit 5: Achieving Macroeconomic Macroeconomic
EquilibriumEquilibrium2. What happens when the price level increases to P = 110?
• At P = 110, the aggregate quantity demanded falls to $5 trillion and the aggregate quantity supplied increases to $9 trillion.
© 2005 Thomson
33Gottheil - Principles of
Economics, 4e
Time Line on Time Line on Equilibrium, Inflation, Equilibrium, Inflation, and Unemploymentand Unemployment
The U.S. commitment to support England during World War II changed the pace and direction of our national economy significantly.
© 2005 Thomson
34Gottheil - Principles of
Economics, 4e
Time Line on Time Line on Equilibrium, Inflation, Equilibrium, Inflation, and Unemploymentand Unemployment
Demand-pull inflation
• Inflation caused primarily by an increase in aggregate demand (such as during wars when government spending increases).
© 2005 Thomson
35Gottheil - Principles of
Economics, 4e
Equilibrium, Inflation, Equilibrium, Inflation, and Unemploymentand Unemployment
Stagflation
• A period of stagnating real GDP, rapid inflation, and relatively high levels of unemployment (oil crisis in the 1970s).
© 2005 Thomson
36Gottheil - Principles of
Economics, 4e
Time Line on Time Line on Equilibrium, Inflation, Equilibrium, Inflation, and Unemploymentand Unemployment
Cost-push inflation
• Inflation caused primarily by a decrease in aggregate supply.
© 2005 Thomson
37Gottheil - Principles of
Economics, 4e
Time Line on Time Line on Equilibrium, Inflation, Equilibrium, Inflation, and Unemploymentand Unemployment• During the second half of the 1980s, the economy was performing about as well as it ever had in the last quarter century.
• Tax reforms, ready credit, leveraged buyouts, a commercial real estate boom, and optimistic expectations contributed to the already strong aggregate demand.
© 2005 Thomson
38Gottheil - Principles of
Economics, 4e
Time Line on Time Line on Equilibrium, Inflation, Equilibrium, Inflation, and Unemploymentand UnemploymentThe recession of 1990-91 was caused
by an inward shift in aggregate demand. Reduced federal revenue sharing with states, downsized government budgets, cuts in demand for military goods, and high levels of debt acquired during the 1980s are all to blame.
© 2005 Thomson
39Gottheil - Principles of
Economics, 4e
The Longest The Longest Prosperity Phase: Prosperity Phase:
1992-2000 (Clinton 1992-2000 (Clinton years)years)Economists attribute the boom to
supply-side factors: • A rise in the nation’s productivity caused by the diffusion of computer technology throughout the economy.
• The absence of rising inflation.
© 2005 Thomson
40Gottheil - Principles of
Economics, 4e
The 2001-02 Recession The 2001-02 Recession and 9/11and 9/11
• The 1992-2000 buying spree left consumers without the means to keep the spree alive.
• Terrorist attacks created a heightened sense of economic uncertainty.
© 2005 Thomson
41Gottheil - Principles of
Economics, 4e
Can We Avoid Can We Avoid Unemployment and Unemployment and
Inflation?Inflation?Although the desired macroequilibrium outcome would occur at a real GDP level consistent with full employment and no inflation, this level is not always achieved.
© 2005 Thomson
42Gottheil - Principles of
Economics, 4e
Can We Avoid Can We Avoid Unemployment and Unemployment and
Inflation?Inflation?Some economists believe government should act in ways to help shift macroequilibrium to this position.
© 2005 Thomson
43Gottheil - Principles of
Economics, 4e
Can We Avoid Can We Avoid Unemployment and Unemployment and
Inflation?Inflation?Increasing or decreasing government spending and income taxes are two methods government can use to attempt to shift the aggregate demand curve.
© 2005 Thomson
44Gottheil - Principles of
Economics, 4e
EXHIBIT 7 OBTAINING FULL-EMPLOYMENT GDP WITHOUT INFLATION
© 2005 Thomson
45Gottheil - Principles of
Economics, 4e
Exhibit 7: Obtaining Full-Exhibit 7: Obtaining Full-Employment GDP Without Employment GDP Without
InflationInflationHow might government shift the aggregate demand curve from AD to AD′ in Exhibit 7? • Government could increase spending and reduce income taxes in order to shift the demand curve to the right.
