Eco 6351 Economics for Managers Chapter 11a. Aggregate Supply and Demand - PowerPoint PPT Presentation


Title: Eco 6351 Economics for Managers Chapter 11a. Aggregate Supply and Demand


1
Eco 6351Economics for ManagersChapter 11a.
Aggregate Supply and Demand
  • Prof. Vera Adamchik

2
The macro economy
DETERMINANTS
OUTCOMES
MACRO ECONOMY
3
Macro view
  • The determinants of macro performance include
  • Internal market forces Population growth,
    spending behavior, invention and innovation, and
    the like.
  • External shocks Wars, natural disasters, trade
    disruptions, and so on.
  • Policy levers Tax policy, government spending
    changes in the availability of money, and
    regulation.

4
Potential GDP
  • The quantity of real GDP supplied when
    unemployment is at its natural rate and there is
    full employment is called potential real GDP.
  • Over the business cycle, employment fluctuates
    around full employment and real GDP fluctuates
    around potential GDP.

5
Two time horizons
  • To study the economy at full employment and over
    the business cycle, we distinguish two time
    frames
  • - the macroeconomic long run,
  • - the macroeconomic short run.

6
  • The macroeconomic long run is a time frame that
    is sufficiently long for economic forces to bring
    real GDP to potential (full-employment) GDP.
  • The macroeconomic short run is a period during
    which real GDP has fallen below or risen above
    potential GDP. At the same time, the unemployment
    rate has risen above or fallen below the natural
    rate.

7
The Aggregate Supply-Aggregate Demand model
  • The AS-AD model enables us to understand three
    features of macroeconomic performance
  • Growth of potential GDP
  • Inflation
  • Business cycle fluctuations

8
Long-run aggregate supply
  • The long-run aggregate supply is vertical because
    potential GDP is independent of the price level.
  • A movement along the LRAS is accompanied by a
    change in two sets of prices the prices of goods
    and services and the prices of productive
    resources. When relative prices remain constant,
    real GDP also remains constant.

9
Long-run aggregate supply
Long Run Aggregate Supply
Potential (Full Employment) GDP
10
Aggregate demand
  • Other things remaining the same, the higher
    the price level, the smaller is the quantity of
    real GDP demanded. This relationship between the
    quantity of real GDP demanded and the price level
    is called aggregate demand.

11
Aggregate demand
  • The AD curve is the relationship between the
    quantity of real GDP demanded and the price level
    in a given time-period, ceteris paribus.
  • The AD curve is downward-sloping the higher the
    price level, the smaller is the quantity of real
    GDP demanded. Reasons real balances effect,
    foreign trade effect, interest rate effect.

12
Aggregate demand
Higher prices
Lower prices
Aggregate demand
Less output demanded
More output demanded
13
Stable or unstable
  • The central concern of macroeconomic theory is
    whether the internal forces of the marketplace
    will generate desired outcomes.

14
Classical theory
  • Prevalent theory prior to the 1930s.
  • The economy is stable because of its ability to
    self-adjust.
  • The cornerstones of the Classical Theory are
    flexible prices and flexible wages.
  • According to Classical economists, government
    intervention in a self-adjusting macroeconomy is
    unnecessary.

15
Says Law
  • According to Says Law, supply creates its own
    demand.
  • Unsold goods will ultimately be sold when buyers
    and sellers find an acceptable price.
  • In the labor market, some people will be
    unemployed, but can find new jobs if they are
    willing to accept lower wages.

16
The Great Depression
  • The Great Depression (1929-1939) was a stunning
    blow to Classical economists.
  • In the Depressions worst year, 1933, the
    production of U.S. farms, factories, shops, and
    offices was only 70 percent of its 1929 level and
    25 percent of the labor force was unemployed.
  • The science of economics had no solutions to the
    Great Depression.

17
Inflation and Unemployment, 1900 1940
Unemployment
Prices
18
The Keynesian revolution
  • John Maynard Keynes provided an alternative to
    the Classical Theory.
  • In 1936, Keynes published The General Theory of
    Employment, Interest, and Money.

19
  • Keynes asserted that the private economy was
    inherently unstable. No self-adjustment.
  • In Keynes view, the inherent instability of the
    marketplace required government intervention
    (Policy levers).

20
  • Keynes focused primarily on the short term. He
    wanted to cure an immediate problem almost
    regardless of the long-term consequences of the
    cure. In the long run, said Keynes, were all
    dead.
  • Keynes believed that after his cure for
    depression had restored the economy to a normal
    condition, the long-term problems of inflation
    and slow economic growth will return.

21
Short-run aggregate supply
  • The short-run aggregate supply curve is the
    relationship between the quantity of real GDP
    supplied and the price level in a given
    time-period, ceteris paribus. That is, when the
    money wage rate and other resource prices remain
    constant.

22
Short-run aggregate supply
  • The aggregate supply curve is upward-sloping the
    output increases when price level rises.
  • The aggregate supply curve is relatively flat
    when capacity is underutilized. It begins to
    slope upward as producers approach capacity.

23
Shape of the SRAS curve
  • Short-Run Aggregate Supply (SRAS) has three
    segments or ranges
  • Horizontal range (Keynesian segment),
  • Intermediate (Upward-sloping) range,
  • Vertical range (Classical segment)

24
Short-run aggregate supply
P
Vertical range
Price level
Horizontal range
Upward-sloping or intermediate range
Q
Real domestic output, GDP
25
Macroeconomic equilibrium
  • Macroeconomic equilibrium occurs when the
    quantity of real GDP demanded equals the quantity
    of real GDP supplied.

26
Macroeconomic equilibriumin the long run and
the short run
27
Macro-equilibrium Real output and the price
level
P
SRAS
Equilibrium in the Horizontal Range
Price Level
Pe
AD
Q
Qe
Q1
Q2
Real Domestic Output, GDP
28
Macro-equilibrium Real output and the price
level
P
SRAS
Equilibrium in the Intermediate Range
Price Level
Pe
P1
AD
Q
Qe
Q1
Q2
Real Domestic Output, GDP
29
Macro failure
  • There are two potential problems with macro
    equilibrium undesirability and instability.

30
Macro Failure
  • Undesirability the price-output relationship at
    equilibrium may not satisfy our macroeconomic
    goals
  • Undesirable Outcomes
  • Unemployment
  • Recession
  • Inflation

31
Three types of short-run macroeconomic equilibrium
  • (1) below full-employment equilibrium (real GDP
    is less than potential GDP and there is a
    recessionary gap)
  • (2) above full-employment equilibrium (real GDP
    exceeds potential GDP and there is an
    inflationary gap)
  • (3) at full-employment equilibrium (real GDP
    equals potential GDP).

32
Below FE equilibrium
Aggregate demand
Aggregate supply
E
PE
F
P
Equilibrium output
Full employment
QE
QF
33
Macro failure
  • Instability even if designated macro
    equilibrium is optimal, it may be displaced by
    macro disturbances.
  • Shifts in aggregate supply and aggregate demand
    can upset a full employment equilibrium.

34
Recurrent shifts
  • Business cycles are a result of recurrent shifts
    of the aggregate supply and demand curves.
  • There are lots of reasons to expect aggregate
    supply and aggregate to shift.

35
Macro disturbances
(b) Demand shifts
(a) Supply shifts
AS1
AS0
AS0
AD0
G
F
P1
F
P
H
P
P2
AD0
AD1
Q2
QF
Q1
QF
36
Origins of a recessionDemand shifts
AS0
E0
E1
AD0
AD1
Q1
QF
37
Origins of a recessionSupply shifts
AS1
AS0
E2
E0
AD0
Q2
QF
38
Origins of a recessionSupply and demand shift
AS1
AS0
E3
E0
AD0
AD1
Q3
QF
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Eco 6351 Economics for Managers Chapter 11a. Aggregate Supply and Demand

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Title: Eco 6351 Economics for Managers Chapter 11a. Aggregate Supply and Demand


1
Eco 6351Economics for ManagersChapter 11a.
Aggregate Supply and Demand
  • Prof. Vera Adamchik

2
The macro economy
DETERMINANTS
OUTCOMES
MACRO ECONOMY
3
Macro view
  • The determinants of macro performance include
  • Internal market forces Population growth,
    spending behavior, invention and innovation, and
    the like.
  • External shocks Wars, natural disasters, trade
    disruptions, and so on.
  • Policy levers Tax policy, government spending
    changes in the availability of money, and
    regulation.

4
Potential GDP
  • The quantity of real GDP supplied when
    unemployment is at its natural rate and there is
    full employment is called potential real GDP.
  • Over the business cycle, employment fluctuates
    around full employment and real GDP fluctuates
    around potential GDP.

5
Two time horizons
  • To study the economy at full employment and over
    the business cycle, we distinguish two time
    frames
  • - the macroeconomic long run,
  • - the macroeconomic short run.

6
  • The macroeconomic long run is a time frame that
    is sufficiently long for economic forces to bring
    real GDP to potential (full-employment) GDP.
  • The macroeconomic short run is a period during
    which real GDP has fallen below or risen above
    potential GDP. At the same time, the unemployment
    rate has risen above or fallen below the natural
    rate.

7
The Aggregate Supply-Aggregate Demand model
  • The AS-AD model enables us to understand three
    features of macroeconomic performance
  • Growth of potential GDP
  • Inflation
  • Business cycle fluctuations

8
Long-run aggregate supply
  • The long-run aggregate supply is vertical because
    potential GDP is independent of the price level.
  • A movement along the LRAS is accompanied by a
    change in two sets of prices the prices of goods
    and services and the prices of productive
    resources. When relative prices remain constant,
    real GDP also remains constant.

9
Long-run aggregate supply
Long Run Aggregate Supply
Potential (Full Employment) GDP
10
Aggregate demand
  • Other things remaining the same, the higher
    the price level, the smaller is the quantity of
    real GDP demanded. This relationship between the
    quantity of real GDP demanded and the price level
    is called aggregate demand.

11
Aggregate demand
  • The AD curve is the relationship between the
    quantity of real GDP demanded and the price level
    in a given time-period, ceteris paribus.
  • The AD curve is downward-sloping the higher the
    price level, the smaller is the quantity of real
    GDP demanded. Reasons real balances effect,
    foreign trade effect, interest rate effect.

12
Aggregate demand
Higher prices
Lower prices
Aggregate demand
Less output demanded
More output demanded
13
Stable or unstable
  • The central concern of macroeconomic theory is
    whether the internal forces of the marketplace
    will generate desired outcomes.

14
Classical theory
  • Prevalent theory prior to the 1930s.
  • The economy is stable because of its ability to
    self-adjust.
  • The cornerstones of the Classical Theory are
    flexible prices and flexible wages.
  • According to Classical economists, government
    intervention in a self-adjusting macroeconomy is
    unnecessary.

15
Says Law
  • According to Says Law, supply creates its own
    demand.
  • Unsold goods will ultimately be sold when buyers
    and sellers find an acceptable price.
  • In the labor market, some people will be
    unemployed, but can find new jobs if they are
    willing to accept lower wages.

16
The Great Depression
  • The Great Depression (1929-1939) was a stunning
    blow to Classical economists.
  • In the Depressions worst year, 1933, the
    production of U.S. farms, factories, shops, and
    offices was only 70 percent of its 1929 level and
    25 percent of the labor force was unemployed.
  • The science of economics had no solutions to the
    Great Depression.

17
Inflation and Unemployment, 1900 1940
Unemployment
Prices
18
The Keynesian revolution
  • John Maynard Keynes provided an alternative to
    the Classical Theory.
  • In 1936, Keynes published The General Theory of
    Employment, Interest, and Money.

19
  • Keynes asserted that the private economy was
    inherently unstable. No self-adjustment.
  • In Keynes view, the inherent instability of the
    marketplace required government intervention
    (Policy levers).

20
  • Keynes focused primarily on the short term. He
    wanted to cure an immediate problem almost
    regardless of the long-term consequences of the
    cure. In the long run, said Keynes, were all
    dead.
  • Keynes believed that after his cure for
    depression had restored the economy to a normal
    condition, the long-term problems of inflation
    and slow economic growth will return.

21
Short-run aggregate supply
  • The short-run aggregate supply curve is the
    relationship between the quantity of real GDP
    supplied and the price level in a given
    time-period, ceteris paribus. That is, when the
    money wage rate and other resource prices remain
    constant.

22
Short-run aggregate supply
  • The aggregate supply curve is upward-sloping the
    output increases when price level rises.
  • The aggregate supply curve is relatively flat
    when capacity is underutilized. It begins to
    slope upward as producers approach capacity.

23
Shape of the SRAS curve
  • Short-Run Aggregate Supply (SRAS) has three
    segments or ranges
  • Horizontal range (Keynesian segment),
  • Intermediate (Upward-sloping) range,
  • Vertical range (Classical segment)

24
Short-run aggregate supply
P
Vertical range
Price level
Horizontal range
Upward-sloping or intermediate range
Q
Real domestic output, GDP
25
Macroeconomic equilibrium
  • Macroeconomic equilibrium occurs when the
    quantity of real GDP demanded equals the quantity
    of real GDP supplied.

26
Macroeconomic equilibriumin the long run and
the short run
27
Macro-equilibrium Real output and the price
level
P
SRAS
Equilibrium in the Horizontal Range
Price Level
Pe
AD
Q
Qe
Q1
Q2
Real Domestic Output, GDP
28
Macro-equilibrium Real output and the price
level
P
SRAS
Equilibrium in the Intermediate Range
Price Level
Pe
P1
AD
Q
Qe
Q1
Q2
Real Domestic Output, GDP
29
Macro failure
  • There are two potential problems with macro
    equilibrium undesirability and instability.

30
Macro Failure
  • Undesirability the price-output relationship at
    equilibrium may not satisfy our macroeconomic
    goals
  • Undesirable Outcomes
  • Unemployment
  • Recession
  • Inflation

31
Three types of short-run macroeconomic equilibrium
  • (1) below full-employment equilibrium (real GDP
    is less than potential GDP and there is a
    recessionary gap)
  • (2) above full-employment equilibrium (real GDP
    exceeds potential GDP and there is an
    inflationary gap)
  • (3) at full-employment equilibrium (real GDP
    equals potential GDP).

32
Below FE equilibrium
Aggregate demand
Aggregate supply
E
PE
F
P
Equilibrium output
Full employment
QE
QF
33
Macro failure
  • Instability even if designated macro
    equilibrium is optimal, it may be displaced by
    macro disturbances.
  • Shifts in aggregate supply and aggregate demand
    can upset a full employment equilibrium.

34
Recurrent shifts
  • Business cycles are a result of recurrent shifts
    of the aggregate supply and demand curves.
  • There are lots of reasons to expect aggregate
    supply and aggregate to shift.

35
Macro disturbances
(b) Demand shifts
(a) Supply shifts
AS1
AS0
AS0
AD0
G
F
P1
F
P
H
P
P2
AD0
AD1
Q2
QF
Q1
QF
36
Origins of a recessionDemand shifts
AS0
E0
E1
AD0
AD1
Q1
QF
37
Origins of a recessionSupply shifts
AS1
AS0
E2
E0
AD0
Q2
QF
38
Origins of a recessionSupply and demand shift
AS1
AS0
E3
E0
AD0
AD1
Q3
QF
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