Aggregate Supply and Aggregate Demand - PowerPoint PPT Presentation


Title: Aggregate Supply and Aggregate Demand


1
Aggregate Supply and Aggregate Demand
2
GDP 2007 to 2010
3
OK One more time..
  • Component parts of GDP?
  • C I G (X-M) GDP
  • Long-Run Aggregate Supply Curve (LRAS)
  • A vertical line representing the real output of
    goods and services after full adjustment has
    occurred
  • It represents the real GDP of the economy under
    conditions of full employment the economy is on
    its production possibilities curve

4
The Production Possibilities and the Economys
Long-Run Aggregate Supply Curve
5
Output Growth and the Long-Run Aggregate Supply
Curve (cont'd)
  • LRAS is vertical Why?
  • Input prices fully adjust to changes in output
    prices
  • Suppliers have no incentive to increase output
  • Unemployment is at the natural rate
  • Determined by technology (or existing resources)

6
Output Growth and the Long-Run Aggregate Supply
Curve (cont'd)
  • Growth is shown by outward shifts of either the
    production possibilities curve or the LRAS curve
    caused by
  • Growth of population and the labor-force
    participation rate
  • Capital accumulation
  • Improvements in technology

7
What is Aggregate Demand?
  • The total amount of goods and services
    demanded in the economy at a given overall price
    level and in a given time period.Represented by
    Aggregate Demand curve (relationship between
    price level and quantity of output firms are
    willing to provide.)

8
Think Why does AD slope downward?
Vertical axis represents Price level for ALL
final goods And services
The aggregate price level Is measured by either
GDP Deflator or CPI
Price level
The horizontal axis represents the real quantity
of all GS purchased as measured by the level of
REAL GDP
AD
Real domestic output, GDP
9
Figure 10-4 The Aggregate Demand Curve
As the price level rises, real GDP declines
10
  • ASSUMPTION for Aggregate demand IS If Price
    level is decreasing, so are incomes.

11
  • There are 3 Reasons that cause the Aggregate
  • Demand Curve to be downward sloping.
  • Real Balance Effect (Wealth effect)
  • Interest Rate Effect
  • International Trade Effect

12
Real Balance Effect
  • Price level falls- causes purchasing power to
    rise translates into more money to spend or
    monetary wealth improves.
  • Real Balance Effect (or wealth effect) Higher
    price level means less consumption spending.

13
Real Balance Effect
The change in the purchasing power of
dollar- Relates to assets that result from a
change in the price level
14
Interest Rate Effect
  • Inverse relationship between price level and
    quantity demanded of GDP because households and
    businesses adjust to interest rates for those
    interest-sensitive purchases.
  • Price level falls (bundle of goods costs less)
    rest of money into savings, more money available
    for borrowing interest rate down.
  • Think of money as stationary demand drives up
    price of money.

15
Interest Rate continued
  • Now if bundle of goods increases want to
    purchase interest sensitive good, cost to borrow
    is up.
  • An increase in money demand will drive up the
    price paid for its use
  • use of money interest rate
  • As price level rises, houses and firms require
    more money to handle transactions

16
International Trade Effect (Open Economy Effect)
  • FYI An open economy is global, a closed economy
    is domestic.
  • The Open Economy Effect
  • Higher price levels result in foreigners
    desiring to buy fewer American-made goods while
    Americans desire more foreign-made goods (i.e.,
    net exports fall).
  • Equivalent to a reduction in the amount of real
    goods and services purchased in the U.S.
  • When Demand for exports decreases, this is an
    unfavorable balance of trade (imports exceed
    exports)

17
Macro AD vs Micro D
  • Aggregate Demand versus Demand for a Single Good
  • When the aggregate demand curve is derived, we
    are looking at the entire circular flow of income
    and product.
  • When a market demand curve is derived, we are
    looking at a single product in one market only.

18
Change in QAD and Change in AD
  • What is the difference?

PL
PL
A
B
AD 2
AD1
GDP
GDP
19
Difference between Quantity of AD and Change of AD
  • QAD movement up or down as result of price
    level changing (ONLY)
  • Change in AD
  • Change in any of the component parts of AD (C
    I G Net Exports)

20
DETERMINANTS OF AGGREGATE DEMAND
Change in Consumer Spending
  • Consumer Wealth
  • Consumer Expectations (expect higher prices)
  • Interest rate (interest sensitive durables)
  • Taxes

21
Changes in Investment Spending
  • Real Interest Rates (rates high- not much I
    taking place)
  • Expected Future Sales (health of economy-
    confidence is big)
  • Business Taxes (higher taxes less profit less
    investment)

22
Government Spending
  • This will be discussed further, but anytime
    government spends, it has an affect on GDP.
  • Infrastructure Health CareSupplies for
    military
  • Education
  • Etc.

23
  • Net Export Spending
  • National Income Abroad-(when foreign nations do
    well, their incomes are higher- can buy more U.S.
    goods and services. U.S. exports rise) China
    an example today.
  • Exchange Rates- Price of one nations currency in
    terms of another. Dollar vs Euro
  • Our currency appreciates if it takes more foreign
    to buy it.. (depreciates if it takes more of
    ours to buy theirs.) 1.00 to 1.25 Euro.
  • Depreciation of nations currency makes foreign
    goods more expensive (but attracts foreigners to
    buy our goods.) Our exports rise. this is why
    the Fed has not worried about our low dollar
    valuation.

24
Long-Run Equilibrium and the Price Level
  • For the economy as a whole, long-run equilibrium
    occurs at the price level where the aggregate
    demand curve (AD) crosses the long-run aggregate
    supply curve (LRAS).

25
Figure 10-5 Long-Run Economywide Equilibrium
26
SRAS?
  • Period where adjustment occurs.
  • Short-Run Aggregate Supply shows the different
    quantities of real output that will be supplied
    at different prices.

27
Things that affect SRAS
  • Aggregate price (increase in QS.)
  • Input prices (increase shift to left)
  • Technology improves (shift to right)
  • Government policy on taxes (lower rates shift
    to right)
  • Investments increase (SAS shifts to right)

28
Common Factor
  • is that any increase in input prices will
    decrease SAS and any decreases in input prices
    will increase production in the SAS.
  • Stated another way
  • anything that is able to change the factor costs
    will be a shift factor of Short-Run Aggregate
    Supply.

29
  • LRAS long-run aggregate supply
  • (a period when nominal wages and other resource
    prices respond to price-level changes)
  • LRAS is a vertical line reflecting that LR
    Aggregate Supply is not affected by changes in
    PL.
  • The LRAS is labeled as the natural level of real
    GDP
  • The natural level of real GDP is defined as the
    level of real GDP that arises when the economy is
    fully employing all of its available input
    resources ( We are in agreement that it hovers
    around 5)

30
Equilibrium States of the Economy
During the time an economy moves from one
equilibrium to another, it is said to be in
disequilibrium.
31
Factors That Change Aggregate Demand
Consumption/Interest Rates
Interest Rate ? ? C? ? AD?
Interest Rate ? ? C ? ? AD?
32
Factors That Change Aggregate Demand
Investment/ Interest Rates
Interest rates ? ? I? ? AD?
Interest rates ? ? I ? ? AD?
33
Factors That Change Aggregate Demand
Investment/ Business Taxes
Business taxes? ? I? ? AD?
Business taxes? ? I? ? AD?
34
Real Rate Of Interest
D2
D1
Money Supply
Can a Change in Money Supply Change AD? Probably
but it is a chain of events.MS changes, then
Interest Rates, then chance in consumption and
investment. Then Change in AD
35
Long Run Aggregate Supply
P
LRASLR
Price level
Long-run Aggregate Supply
Full-Employment
Q
Qf
Real domestic output, GDP
36
Unanticipated Increase in Aggregate Demand
  • In response to an unanticipated increase in AD
    for goods services (shift from AD1 to AD2),
    prices will rise to P105 and output will
    temporarily exceed full-employment capacity
    (increases to Y2).

37
Growth in Aggregate Supply
  • Here we illustrate the impact of economic growth
    due to capital formation or a technological
    advancement, for example.
  • Both LRAS and SRAS increase (to LRAS2 and SRAS2)
    the full employment output of the economy expands
    from YF1 to YF2.
  • A sustainable, higher level of real output and
    real income is the result. If the money
    supply is held constant, a new long-run
    equilibrium will emerge at a larger output rate
    (YF2) and lower price level (P2).

38
Effects of Adverse Supply Shock
  • The higher resource prices shift the SRAS curve
    to the left in the short-run, the price level
    rises to P110 and output falls to Y2.
  • What happens in the long-run depends on whether
    the reduction in the supply of resources is
    temporary or permanent.
  • If temporary, resource prices fall in the future,
    permitting the economy to return to its original
    equilibrium (A).
  • If permanent, the productive potential of the
    economy will shrink (LRAS shifts to the left) and
    (B) will become the long-run equilibrium.

39
INCREASES IN AD DEMAND-PULL INFLATION
P
AS
AD1
AD2
P2
Price Level
P1
Q
Q1
Q2
Qf
Real Domestic Output, GDP
40
DECREASES IN AS COST-PUSH INFLATION
AS2
P
AS1
b
P2
Price Level
a
P1
AD1
Q
Q1
Qf
Real Domestic Output, GDP
41
(No Transcript)
42
  • Non-governmental actions that
  • Shift AS left
  • Raw materials cost rise
  • Wages rise faster than productivity
  • Worker productivity decreases
  • Obsolescence
  • Wars
  • Natural disasters

43
Fiscal Policy
  • Governmental actions that shift AD
  • Shift AD right
  • Govt spending increases
  • Taxes decreases
  • Money Supply increases
  • Shift AD left
  • G decreases
  • T increases
  • MS decreases

44
KILEY SAYS THAT'S ALL!
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Aggregate Supply and Aggregate Demand

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Title: Aggregate Supply and Aggregate Demand


1
Aggregate Supply and Aggregate Demand
2
GDP 2007 to 2010
3
OK One more time..
  • Component parts of GDP?
  • C I G (X-M) GDP
  • Long-Run Aggregate Supply Curve (LRAS)
  • A vertical line representing the real output of
    goods and services after full adjustment has
    occurred
  • It represents the real GDP of the economy under
    conditions of full employment the economy is on
    its production possibilities curve

4
The Production Possibilities and the Economys
Long-Run Aggregate Supply Curve
5
Output Growth and the Long-Run Aggregate Supply
Curve (cont'd)
  • LRAS is vertical Why?
  • Input prices fully adjust to changes in output
    prices
  • Suppliers have no incentive to increase output
  • Unemployment is at the natural rate
  • Determined by technology (or existing resources)

6
Output Growth and the Long-Run Aggregate Supply
Curve (cont'd)
  • Growth is shown by outward shifts of either the
    production possibilities curve or the LRAS curve
    caused by
  • Growth of population and the labor-force
    participation rate
  • Capital accumulation
  • Improvements in technology

7
What is Aggregate Demand?
  • The total amount of goods and services
    demanded in the economy at a given overall price
    level and in a given time period.Represented by
    Aggregate Demand curve (relationship between
    price level and quantity of output firms are
    willing to provide.)

8
Think Why does AD slope downward?
Vertical axis represents Price level for ALL
final goods And services
The aggregate price level Is measured by either
GDP Deflator or CPI
Price level
The horizontal axis represents the real quantity
of all GS purchased as measured by the level of
REAL GDP
AD
Real domestic output, GDP
9
Figure 10-4 The Aggregate Demand Curve
As the price level rises, real GDP declines
10
  • ASSUMPTION for Aggregate demand IS If Price
    level is decreasing, so are incomes.

11
  • There are 3 Reasons that cause the Aggregate
  • Demand Curve to be downward sloping.
  • Real Balance Effect (Wealth effect)
  • Interest Rate Effect
  • International Trade Effect

12
Real Balance Effect
  • Price level falls- causes purchasing power to
    rise translates into more money to spend or
    monetary wealth improves.
  • Real Balance Effect (or wealth effect) Higher
    price level means less consumption spending.

13
Real Balance Effect
The change in the purchasing power of
dollar- Relates to assets that result from a
change in the price level
14
Interest Rate Effect
  • Inverse relationship between price level and
    quantity demanded of GDP because households and
    businesses adjust to interest rates for those
    interest-sensitive purchases.
  • Price level falls (bundle of goods costs less)
    rest of money into savings, more money available
    for borrowing interest rate down.
  • Think of money as stationary demand drives up
    price of money.

15
Interest Rate continued
  • Now if bundle of goods increases want to
    purchase interest sensitive good, cost to borrow
    is up.
  • An increase in money demand will drive up the
    price paid for its use
  • use of money interest rate
  • As price level rises, houses and firms require
    more money to handle transactions

16
International Trade Effect (Open Economy Effect)
  • FYI An open economy is global, a closed economy
    is domestic.
  • The Open Economy Effect
  • Higher price levels result in foreigners
    desiring to buy fewer American-made goods while
    Americans desire more foreign-made goods (i.e.,
    net exports fall).
  • Equivalent to a reduction in the amount of real
    goods and services purchased in the U.S.
  • When Demand for exports decreases, this is an
    unfavorable balance of trade (imports exceed
    exports)

17
Macro AD vs Micro D
  • Aggregate Demand versus Demand for a Single Good
  • When the aggregate demand curve is derived, we
    are looking at the entire circular flow of income
    and product.
  • When a market demand curve is derived, we are
    looking at a single product in one market only.

18
Change in QAD and Change in AD
  • What is the difference?

PL
PL
A
B
AD 2
AD1
GDP
GDP
19
Difference between Quantity of AD and Change of AD
  • QAD movement up or down as result of price
    level changing (ONLY)
  • Change in AD
  • Change in any of the component parts of AD (C
    I G Net Exports)

20
DETERMINANTS OF AGGREGATE DEMAND
Change in Consumer Spending
  • Consumer Wealth
  • Consumer Expectations (expect higher prices)
  • Interest rate (interest sensitive durables)
  • Taxes

21
Changes in Investment Spending
  • Real Interest Rates (rates high- not much I
    taking place)
  • Expected Future Sales (health of economy-
    confidence is big)
  • Business Taxes (higher taxes less profit less
    investment)

22
Government Spending
  • This will be discussed further, but anytime
    government spends, it has an affect on GDP.
  • Infrastructure Health CareSupplies for
    military
  • Education
  • Etc.

23
  • Net Export Spending
  • National Income Abroad-(when foreign nations do
    well, their incomes are higher- can buy more U.S.
    goods and services. U.S. exports rise) China
    an example today.
  • Exchange Rates- Price of one nations currency in
    terms of another. Dollar vs Euro
  • Our currency appreciates if it takes more foreign
    to buy it.. (depreciates if it takes more of
    ours to buy theirs.) 1.00 to 1.25 Euro.
  • Depreciation of nations currency makes foreign
    goods more expensive (but attracts foreigners to
    buy our goods.) Our exports rise. this is why
    the Fed has not worried about our low dollar
    valuation.

24
Long-Run Equilibrium and the Price Level
  • For the economy as a whole, long-run equilibrium
    occurs at the price level where the aggregate
    demand curve (AD) crosses the long-run aggregate
    supply curve (LRAS).

25
Figure 10-5 Long-Run Economywide Equilibrium
26
SRAS?
  • Period where adjustment occurs.
  • Short-Run Aggregate Supply shows the different
    quantities of real output that will be supplied
    at different prices.

27
Things that affect SRAS
  • Aggregate price (increase in QS.)
  • Input prices (increase shift to left)
  • Technology improves (shift to right)
  • Government policy on taxes (lower rates shift
    to right)
  • Investments increase (SAS shifts to right)

28
Common Factor
  • is that any increase in input prices will
    decrease SAS and any decreases in input prices
    will increase production in the SAS.
  • Stated another way
  • anything that is able to change the factor costs
    will be a shift factor of Short-Run Aggregate
    Supply.

29
  • LRAS long-run aggregate supply
  • (a period when nominal wages and other resource
    prices respond to price-level changes)
  • LRAS is a vertical line reflecting that LR
    Aggregate Supply is not affected by changes in
    PL.
  • The LRAS is labeled as the natural level of real
    GDP
  • The natural level of real GDP is defined as the
    level of real GDP that arises when the economy is
    fully employing all of its available input
    resources ( We are in agreement that it hovers
    around 5)

30
Equilibrium States of the Economy
During the time an economy moves from one
equilibrium to another, it is said to be in
disequilibrium.
31
Factors That Change Aggregate Demand
Consumption/Interest Rates
Interest Rate ? ? C? ? AD?
Interest Rate ? ? C ? ? AD?
32
Factors That Change Aggregate Demand
Investment/ Interest Rates
Interest rates ? ? I? ? AD?
Interest rates ? ? I ? ? AD?
33
Factors That Change Aggregate Demand
Investment/ Business Taxes
Business taxes? ? I? ? AD?
Business taxes? ? I? ? AD?
34
Real Rate Of Interest
D2
D1
Money Supply
Can a Change in Money Supply Change AD? Probably
but it is a chain of events.MS changes, then
Interest Rates, then chance in consumption and
investment. Then Change in AD
35
Long Run Aggregate Supply
P
LRASLR
Price level
Long-run Aggregate Supply
Full-Employment
Q
Qf
Real domestic output, GDP
36
Unanticipated Increase in Aggregate Demand
  • In response to an unanticipated increase in AD
    for goods services (shift from AD1 to AD2),
    prices will rise to P105 and output will
    temporarily exceed full-employment capacity
    (increases to Y2).

37
Growth in Aggregate Supply
  • Here we illustrate the impact of economic growth
    due to capital formation or a technological
    advancement, for example.
  • Both LRAS and SRAS increase (to LRAS2 and SRAS2)
    the full employment output of the economy expands
    from YF1 to YF2.
  • A sustainable, higher level of real output and
    real income is the result. If the money
    supply is held constant, a new long-run
    equilibrium will emerge at a larger output rate
    (YF2) and lower price level (P2).

38
Effects of Adverse Supply Shock
  • The higher resource prices shift the SRAS curve
    to the left in the short-run, the price level
    rises to P110 and output falls to Y2.
  • What happens in the long-run depends on whether
    the reduction in the supply of resources is
    temporary or permanent.
  • If temporary, resource prices fall in the future,
    permitting the economy to return to its original
    equilibrium (A).
  • If permanent, the productive potential of the
    economy will shrink (LRAS shifts to the left) and
    (B) will become the long-run equilibrium.

39
INCREASES IN AD DEMAND-PULL INFLATION
P
AS
AD1
AD2
P2
Price Level
P1
Q
Q1
Q2
Qf
Real Domestic Output, GDP
40
DECREASES IN AS COST-PUSH INFLATION
AS2
P
AS1
b
P2
Price Level
a
P1
AD1
Q
Q1
Qf
Real Domestic Output, GDP
41
(No Transcript)
42
  • Non-governmental actions that
  • Shift AS left
  • Raw materials cost rise
  • Wages rise faster than productivity
  • Worker productivity decreases
  • Obsolescence
  • Wars
  • Natural disasters

43
Fiscal Policy
  • Governmental actions that shift AD
  • Shift AD right
  • Govt spending increases
  • Taxes decreases
  • Money Supply increases
  • Shift AD left
  • G decreases
  • T increases
  • MS decreases

44
KILEY SAYS THAT'S ALL!
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