Chapter 10 Lecture Presentation - Dasha Safonovadashasafonova.com/spring16/w10_AS-AD_handout.pdf ·...
Transcript of Chapter 10 Lecture Presentation - Dasha Safonovadashasafonova.com/spring16/w10_AS-AD_handout.pdf ·...
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W10: AS-AD Model • Short run vs. long run
• Aggregate supply
• Aggregate demand
• Short run and long run macroeconomic equilibria
• Business cycle in the AS-AD model
• Inflation cycles
Reading: • CH10 pg.242-254 • CH12 pg.296, 301-09, until “The quantity theory of money”
HW: TBA
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Short Run vs. Long Run
We distinguish two time frames associated with different states of the labor market:
§ Short-run – nominal wages do not change
§ Long-run – nominal wages change
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The quantity of real GDP supplied is the total quantity that firms plan to produce during a given period
Short-run aggregate supply is the relationship between the quantity of real GDP supplied and the price level when the nominal wages, the prices of other resources, and potential GDP remain constant
Long-run aggregate supply is the relationship between the quantity of real GDP supplied and the price level when real GDP equals potential GDP
Aggregate Supply
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Short Run and Long Run Aggregate Supply
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Short Run and Long Run Aggregate Supply
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Increase in Potential GDP
Potential GDP increases for three reasons:
§ An increase in the full-employment quantity of labor
§ An increase in the quantity of capital (physical or human)
§ An advance in technology
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Increase in Potential GDP
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Aggregate Demand
The quantity of real GDP demanded:
Y = C + I + G + X – M
Aggregate demand is the relationship between the quantity of real GDP demanded and the price level
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Aggregate Demand Curve
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Why Is AD Curve Downward Sloping?
A rise in the price level, all else held constant, decreases real wages
ê
People decrease spending
ê
The quantity of real GDP demanded decreases
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Changes in Aggregate Demand
Aggregate demand curve shifts because of:
§ Expectations about future incomes and inflation
§ Fiscal policy and monetary policy
§ The world economy
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Changes in Aggregate Demand
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Short-Run Macroeconomic Equilibrium
Short-run macroeconomic equilibrium occurs when the quantity of real GDP demanded equals the quantity of real GDP supplied at the point of intersection of the AD curve and the SAS curve
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Short-Run Macroeconomic Equilibrium
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Long-run macroeconomic equilibrium occurs when real GDP equals potential GDP – when the economy is on its LAS curve
Long-run equilibrium occurs at the intersection of the AD and LAS curves
Long-Run Macroeconomic Equilibrium
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Long-Run Macroeconomic Equilibrium
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Long-Run Macroeconomic Equilibrium
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What Is Business Cycle?
Peak
Trough
Contraction
Expa
nsio
n
Peak
Trough
Expa
nsio
n Contraction
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US Business Cycle Expansions and Contractions
• Contractions (recessions) start at the peak of a business cycle and end at the trough
• Expansions start at the trough of a business cycle and end at the peak
• Cycle: 1. Trough from previous trough or 2. Peak from previous peak
http://www.nber.org/cycles.html
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Mainstream Business Cycle Theory
• Potential GDP grows at a steady pace
• Aggregate demand grows at a fluctuating rate
• Real GDP fluctuates around potential GDP
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Potential GDP increases to $16 trillion and the LAS curve shifts rightward.
The Business Cycle
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The Business Cycle
During an expansion, aggregate demand increases and usually by more than potential GDP.
The AD curve shifts to AD1.
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The Business Cycle
The SAS shifts to SAS1.
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The Business Cycle
But if aggregate demand increases more slowly than potential GDP, the AD curve shifts to AD2.
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The Business Cycle
But if aggregate demand increases more quickly than potential GDP, the AD curve shifts to AD3.
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Inflation Cycles • In the long run, inflation occurs if the quantity of money
grows faster than potential GDP
• In the short run, many factors can start an inflation, and real GDP and the price level interact
• To study these interactions, we distinguish between two sources of inflation:
§ Demand-pull inflation § Cost-push inflation
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Demand-Pull Inflation
An inflation that starts because aggregate demand increases
Examples:
• a cut in the interest rate
• an increase in the quantity of money
• an increase in government expenditure
• a tax cut
• an increase in investment stimulated by an increase in expected future profits
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Demand-Pull Inflation
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Demand-Pull Inflation
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Demand-Pull Inflation
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Cost-Push Inflation
An inflation that starts with an increase in costs
Two main sources of increased costs: 1. An increase in the money wage rate 2. An increase in the money price of raw materials, such as oil
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Cost-Push Inflation
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• The initial increase in costs creates a one-time rise in the price level, not inflation
• To create inflation, aggregate demand must increase
• That is, the Fed must increase the quantity of money persistently
Cost-Push Inflation
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Cost-Push Inflation
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Cost-Push Inflation