Aggregate Demand and Supply - PowerPoint PPT Presentation

Loading...

PPT – Aggregate Demand and Supply PowerPoint presentation | free to download - id: 56bbed-ZjkxY



Loading


The Adobe Flash plugin is needed to view this content

Get the plugin now

View by Category
About This Presentation
Title:

Aggregate Demand and Supply

Description:

Aggregate Demand and Supply Note: Reading is posted under additional materials on course website not under electronic course reserve. – PowerPoint PPT presentation

Number of Views:574
Avg rating:3.0/5.0
Slides: 44
Provided by: BrianB161
Learn more at: http://marriottschool.net
Category:

less

Write a Comment
User Comments (0)
Transcript and Presenter's Notes

Title: Aggregate Demand and Supply


1
Aggregate Demand and Supply
  • Note Reading is posted under additional
    materials on course website not under
    electronic course reserve.

2
Stable Prices
  • Why is inflation bad?
  • If wages and prices move together, what is wrong
    with inflation?
  • Prices key to allocating resources
  • Risk the higher the level of inflation, the more
    volatile it becomes.
  • Makes economic decisions difficult
  • Stems production of output
  • Can lead to unanticipated swings in output.

3
Stable Output
  • Why is volatile output bad?
  • Creates risk for investors
  • Investors demand compensation for bearing risk
  • Firms face higher cost of borrowing
  • Lower borrowing implies lower output.

4
Level and Volatility of Growth
5
Level and Volatility of Growth
  • If GDP grows by 4 annually
  • Output doubles in about 18 years
  • If GDP grows by 2 annually
  • Output grows by about 40 in 18 years

6
Is Government Policy Useful?
  • Can government policy lower inflation? Or does
    policy just add extra volatility to inflation?
  • Can government policy reduce fluctuations in the
    business cycle and lower the volatility of
    output?
  • Monetariasts vs. Keynsians

7
Aggregate Demand
  • Aggregate demand total quantity of an economys
    goods and services demanded at each price level.
  • Single good output or GNP
  • Ynumber of goods produced
  • Yreal output
  • Single price
  • Pprice of one unit of Y
  • PYnominal spending (or nominal output)
  • Mmoney supply

8
Aggregate Demand
  • Demand curve for an individual asset relates
    demand for the asset to the price of the asset
    relative to other goods.
  • Aggregate demand curve relates demand for output
    to general price level.
  • If all prices decrease by 10, why should
    aggregate demand increase?

9
Aggregate Demand
  • When general price level decreases investors have
    the option of either
  • Buying more of some good
  • Holding more dollars
  • Assuming holding real goods is better than
    holding dollars, as price level decreases,
    aggregate demand increases
  • Real money supply purchasing power of M M/P
  • When prices decrease, M/P increases holding M
    constant.

10
Aggregate Demand
  • Island Economy
  • Current money supply M2 dollars
  • Price of a gallon of milk 2 dollars
  • Price of a loaf of bread 2 dollars
  • Each day

2
milk
Baker
Farmer
bread
2
11
Aggregate Demand
  • Each day total aggregate demand 2
  • 1 loaf of bread
  • 1 gallon of milk
  • Y2
  • Same 2 gets spent twice
  • Total nominal spending 4 PY
  • Velocity (PY)/M 4/2 2

12
Aggregate Demand
  • Assume money supply is constant
  • Assume prices decrease
  • Bread 1
  • Milk1
  • Farmer can now begin day by buying more than 1
    loaf of bread.
  • Baker can then buy more gallons of milk.

13
Aggregate Demand
  • Assume
  • farmer buys 2 loaves of bread
  • baker buys 2 gallons of milk
  • Each day total aggregate demand 4
  • 2 loaves of bread
  • 2 gallons of milk
  • Y4
  • Same 2 gets spent twice
  • Total nominal spending 4 PY14
  • Velocity (PY)/M 4/2 2

14
Velocity
  • Velocity the same dollar is spent several times
    within an economy.

As prices decrease, Y increases holding V and M
constant.
15
Aggregate Demand
P
Aggregate Output Demanded, Y
16
Keynsians
  • Aggregate demand is determined by the sum of the
    parts

17
Keynsians
  • Holding prices constant, a change in demand by
    any one sector will change aggregate demand.
  • Demand curve shifts right with
  • Increases in government spending
  • Decreases in taxes
  • Increases in money supply, M.
  • Business/Consumer optimism
  • Increase in Exports

18
Monetariast View
  • The only factor that shifts the demand curve is
    the money supply.
  • If government increases spending, why does that
    not increase aggregate demand?
  • Monetariast answer complete crowding out.
  • To buy more, government must issue bonds
  • Shifts supply of bonds to the right
  • Increases yield
  • Consumers cannot afford to borrow
  • Consumer demand declines

19
Long Run Aggregate Supply LRS
  • Determined by
  • The amount of capital
  • The amount of labor (natural rate of
    unemployment)
  • Available technology
  • In the long run, the farmer and baker dont have
    the ability to continually produce 2 loaves of
    bread and 2 gallons of milk.
  • Prices rise
  • Output decreases

20
Long-Run Aggregate Supply
P
Aggregate Output, Y
21
Short Run Aggregate Supply SRS
  • Firms are seeking to maximize profits
  • Face increasing marginal cost
  • Produce where pricemarginal cost
  • As prices increase firms are willing to produce
    more

22
Short Run Aggregate Supply SRS
  • Example Firm produces widgets
  • Price at which they can sell 10
  • To produce Cost Profit
  • 1st 3 7
  • 2nd 5 5
  • 3rd 9.99 .01

23
Short Run Aggregate Supply SRS
  • As prices increase firms are willing to produce
    more to maximize profits
  • Is short run, production (labor) costs do not
    change.
  • Wages are set by long-term contracts
  • (about 70 of production costs)
  • Raw materials bought in advance
  • SRS curve slopes up
  • Holding price constant, an increase in production
    costs shifts supply curve to the left
  • An increase in the cost of the factors of
    production

24
SRS
P
Short-run supply curve shifts left as costs of
production increase.
Aggregate Output SuppliedY
25
SRS
  • Factors that can shift SRS curve to left
  • Increasing wages
  • Increasing expected inflation
  • Inflation erodes purchasing power of wages.
    Workers will demand higher wages.
  • Strikes
  • Increasing production costs other than wages.
  • Natural disasters
  • Increases in price of oil

26
Equilibrium
Labor market is loose Low demand for
workers Downward pressure on wages
P
Labor market is tight Large demand for
workers Upward pressure on wages
Aggregate Output, Y
Long Run Aggregate Supply Determined by natural
rate of unemployment
27
Equilibrium
  • Keynsians
  • Wages are sticky.
  • Short-run aggregate supply is slow to shift,
    particularly when unemployment is high.
  • Government is needed to restore economy to
    equilibrium.
  • Government spending
  • Lowering taxes

28
Keynsian View
P
3.
Government spending shifts demand to right
2.
1.
Aggregate Output, Y
29
Keynsian View
  • Increased government spending can increase
    aggregate demand and lower unemployment.
  • Wages are slow to adjust, so the economy stays
    out of equilibrium for several years.
  • Eventually wages increase and short-run supply
    shifts left.
  • The long-run effect is just inflation.

30
Keynsian View
P
2.
1.
Aggregate Output, Y
31
Keynsian View
  • If economy is initially out of equilibrium
  • Wages are slow to adjust, so the economy can stay
    out of equilibrium for several years.
  • Increased government spending can increase
    aggregate demand.
  • Lower unemployment at the cost of inflation.
  • Keynsian view is benefit outweighs costs

32
Monetariast View
P
3.
2.
1.
Aggregate Output, Y
33
Non-Activist Monetary View
  • Assume short-run supply shifts left
  • Economy gets kicked out of equilibrium
  • Government can shift demand curve right by
    increasing the money supply
  • But before this happens, SRS shifts back right,
    since wages adjust fast
  • When demand curve shifts right, economy gets
    kicked out of equilibrium again
  • SRS shifts back left

34
Monetariast View
  • Result of policy
  • Increases volatility of output
  • Increases inflation
  • Conclusions The Fed does more harm than good
    when it tries to tinker with money supply.

35
Non-activist Argument
  • Data Lag it takes time for policy makers to
    obtain the data that tell them whats going on.
  • Data on quarterly GDP not available for several
    months until after the quarter.
  • Recognition lag it takes time for policy makers
    to realize what the data is saying about the
    future.
  • NBER wont classify the economy in a recession
    until 6 months after it determines one might have
    begun.
  • Effectiveness lag Once money supply has
    changed, it can take time for effects to be
    carried out

36
Deflation
  • Nearly all economists agree deflation is at least
    as bad as inflation
  • With deflation, greater defaults on loans
  • Greater bank failure
  • Capital cannot be channeled to good investments
  • Real output declines
  • May have long run effects

37
Monetariast View
  • To prevent deflation, grow money supply at a
    small constant rate.
  • Result will be moderate inflation from year to
    year, but benefit will be a hedge against
    deflation.

38
Keynsian View
P
2.
3.
1.
Aggregate Output, Y
39
Keynsian View
  • Assume short-run supply shifts left
  • Economy gets kicked out of equilibrium
  • Government can shift demand curve right by
    increasing the money supply
  • Wages are not perfectly flexible
  • Demand curve shifts right before supply curve
    shifts back right.
  • Result of intervention is
  • Faster return to long run output level at cost of
    moderate inflation
  • Activist view is that benefits outweigh costs.

40
Keynsian View
P
With no intervention
1.
3.
2.
Original equilibrium
Aggregate Output, Y
41
Keynsian View
  • Assume demand curve shifts right (irrational
    exuberance)
  • Economy gets kicked out of equilibrium
  • Government can shift demand curve left by
    decreasing the money supply
  • Demand curve shifts left before supply curve
    shifts left.
  • Result of intervention is
  • Faster return to long run output level at cost of
    moderate inflation
  • Lower and less volatile inflation

42
Keynsian View
P
2.
Original equilibrium
1.
With no intervention
Aggregate Output, Y
43
Keynsian View
  • Assume demand curve shifts left (irrational
    pessimism)
  • Economy gets kicked out of equilibrium
  • Government can shift demand curve right by
    increasing the money supply
  • Hopefully economy never gets to point 1.
  • Argument in favor of increasing money supply at
    small rate that may vary over time according to
    business optimism/pessimism.
  • Result of intervention is
  • No deflation at cost of some moderate inflation
  • Activist view is that benefit outweighs cost.
About PowerShow.com