Ch. 7: Aggregate Demand and Supply - PowerPoint PPT Presentation

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Ch. 7: Aggregate Demand and Supply

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Title: Ch. 7: Aggregate Demand and Supply


1
Ch. 7 Aggregate Demand and Supply
  • Aggregate supply
  • Aggregate demand
  • Macroeconomic equilibrium.
  • Effects of changes in aggregate supply and
    aggregate demand on economic growth, inflation,
    and business cycles
  • Explain U.S. economic growth, inflation, and
    business cycles by using the AS-AD model.

2
Aggregate Supply
  • Aggregate Supply Fundamentals
  • Long-run aggregate supply
  • Short-run aggregate supply

3
Aggregate Supply
  • Long-Run Aggregate Supply (LRAS)
  • relationship between the quantity of real GDP
    supplied and the price level when real GDP equals
    potential GDP.
  • Position of LRAS determined by
  • Labor supply
  • Labor demand
  • Production function

4
The combination of the labor market equilibrium
and the production function determine the
potential level of GDP and the position of the
LRAS
5
Aggregate Supply
  • The LAS curve is vertical because potential GDP
    is independent of the price level.
  • Along the LAS curve all input and output prices
    vary by the same percentage so that relative
    prices and the real wage rate remain constant.

6
Aggregate Supply
  • How will each of the following affect the
    position of the LAS curve?
  • increase in labor supply
  • Increase in labor demand
  • Upward shift of the production function

7
Aggregate Supply
  • Short-Run Aggregate Supply (SRAS)
  • The macroeconomic short run
  • a period during which some prices have not
    adjusted to the long run equilibrium
  • real GDP may fall below or rise above potential
    GDP.
  • the unemployment rate may rise above or fall
    below the natural unemployment rate.
  • SRAS is the relationship between the quantity of
    real GDP supplied and the price level in the
    short-run when the money wage rate, the prices of
    other resources, and potential GDP remain
    constant.

8
Aggregate Supply
  • Along the SAS curve, a rise in the price level
    with no change in the money wage rate and other
    input prices increases the quantity of real GDP
    suppliedthe SAS curve is upward sloping.

9
Aggregate Supply
  • The SAS curve is upward sloping because
  • If money wage is fixed, as price level rises,
    real wage falls and firms hire more workers.
  • If P105
  • SASLAS
  • labor market in equilibrium
  • Unemployment ratenatural rate
  • No pressure on real wages

10
Aggregate Supply
  • If Pgt105
  • SASgtLAS
  • real wage lt equilibrium
  • Shortage of labor
  • Unemplltnatural rate
  • Upward pressure on real wages
  • If Plt105
  • SASltLAS
  • real wage gt equilibrium
  • surplus of labor
  • Unemplgtnatural rate
  • Downward pressure on real wages

11
Aggregate Supply
  • Movement along the LAS and SAS Curves
  • A change in the price level with no change in the
    money wage causes a movement along the SAS curve.

12
Aggregate Supply
  • If real wageltequilibrium
  • Real wages rise in long run
  • SAS shifts left
  • If real wagegtequilibrium
  • Real wages fall in long run
  • SAS shifts right

13
Aggregate Supply
  • Changes in Aggregate Supply
  • When potential GDP increases, both the LRAS and
    SRAS curves shift rightward.
  • Sources of change in Potential GDP
  • Change in the full-employment quantity of labor.
  • Change in the quantity of capital (physical or
    human).
  • Advance in technology.

14
Aggregate Demand
  • AD C I G X M.
  • Same as expenditure side of GDP
  • Cconsumption expenditures
  • I investment
  • G government purchases,
  • X M net exports

15
Aggregate Demand
  • The AD curve (drawn against P) slopes downward
    because when prices rise
  • Wealth effect real value of wealth decreases.
  • Intertemporal substitution effects interest
    rates rise
  • International substitution effects Exports fall,
    imports rise

16
Aggregate Demand
  • Changes in Aggregate Demand
  • Expectations
  • Future income, future profits, future inflation
  • Fiscal policy
  • Net Taxes (taxes transfers)
  • Government purchases
  • Monetary policy
  • Interest rates affect investment, consumption.
  • The world economy.
  • Exports and imports

17
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
    SRAS curve.
  • Long-run macroeconomic equilibrium
  • occurs when real GDP equals potential GDPwhen
    the economy is on its LRAS curve.

18
Macroeconomic Equilibrium
  • LR equilibrium occurs
  • where the AD and LRAS curves intersect
  • results when the money wage has adjusted to put
    the SRAS curve through the long-run equilibrium
    point.

19
Macroeconomic Equilibrium
  • The Business Cycle
  • The business cycle occurs because AD and SRAS
    fluctuate but the money wage does not change
    rapidly enough to keep real GDP at potential GDP.

20
Macroeconomic Equilibrium
  • A long-run equilibrium is an equilibrium in which
    potential GDP equals real GDP.
  • Unemplnatural rate
  • No pressure on real wages

P
LRAS
SRAS
AD
Real GDP
21
Macroeconomic Equilibrium
  • Equilibrium below full employment
  • potential GDP exceeds real GDP.
  • Recessionary gap
  • Unemplgtnatural rate
  • Downward pressure on real wages
  • SRAS will eventually shift right

P
LRAS
SRAS
AD
Real GDP
22
Macroeconomic Equilibrium
  • Equilibrium above full employment
  • real GDP exceeds potential GDP.
  • Inflationary gap
  • Unempl lt natural rate
  • Upward pressure on real wages
  • SRAS will eventually shift left

P
LRAS
SRAS
AD
Real GDP
23
Fluctuations in Aggregate Demand
  • An increase in aggregate demand shifts the AD
    curve rightward.
  • SR effect on
  • Prices
  • Real GDP
  • Real wages
  • Unemployment

24
Fluctuations in Aggregate Demand
  • In LR,
  • upward pressure on real wages causes money wage
    to rise and shifts SAS leftward until return to
    LR equilibrium.
  • As move from A to B, effect on
  • Prices
  • Real wages
  • Unemployment
  • Real GDP

B
A
25
Macroeconomic Equilibrium
  • Fluctuations in Aggregate Supply
  • Starting at LR equilibrium, a rise in the price
    of oil decreases short-run aggregate supply and
    the SRAS curve shifts leftward.

26
U.S. Economic Growth, Inflation, and Cycles
  • Changes in real GDP and the price level each year
    from 1963 to 2003 in terms of shifting AD, SAS,
    and LAS curves.

27
Using the AS/AD model
  • Starting from a LR equilibrium, examine the SR
    and LR effect of
  • Tax cut
  • Increase in government spending
  • Fed cuts interest rates
  • Consumer confidence rises
  • Temporary supply shock
  • Assume NO EFFECT on LRAS (to be considered
    later)
  • Variables to consider
  • price, real wage, real GDP, unemployment.
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