Chapter 13: Aggregate Demand and Aggregate Supply - PowerPoint PPT Presentation

Loading...

PPT – Chapter 13: Aggregate Demand and Aggregate Supply PowerPoint presentation | free to download - id: 59831b-OGFjM



Loading


The Adobe Flash plugin is needed to view this content

Get the plugin now

View by Category
About This Presentation
Title:

Chapter 13: Aggregate Demand and Aggregate Supply

Description:

Title: Working With Our Basic Aggregate Demand / Supply Model Author: James Gwartney and Charles D. Skipton Last modified by: Berkeley User Created Date – PowerPoint PPT presentation

Number of Views:255
Avg rating:3.0/5.0
Slides: 44
Provided by: JamesGwar
Learn more at: http://www.crawfordsworld.com
Category:

less

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

Title: Chapter 13: Aggregate Demand and Aggregate Supply


1
Chapter 13Aggregate Demand and Aggregate Supply
2
  • Aggregate Demand for Goods Services

3
Aggregate Demand for Goods Services
  • Aggregate demand curve -- indicates the various
    quantities of domestically produced goods
    services that purchasers are willing to buy
    at different price levels .
  • The AD curve slopes downward to the right,
    indicating an inverse relationship between the
    amount of goods services demanded and the price
    level.

4
Aggregate Demand Curve
5
Why Does the Aggregate Demand Curve Slope
Downward
  • The Wealth Effect A lower price level will
    increase the purchasing power of the fixed
    quantity of money.
  • The Interest Rate Effect A lower price level
    will make the nominal interest rate appear lower
    which will stimulate additional purchases during
    the current period.
  • The Foreign Purchases Effect Other things
    constant, a lower price level will make
    domestically produced goods less expensive
    relative to foreign goods.

6
  • Factors that Shift Aggregate Demand

7
Factors that Shift Aggregate Demand
  • A change of businesses and consumers Expectations
    about the future
  • A change in Real Wealth. .
  • A change in Consumer Debt.
  • A change in Taxes or Government Spending.

8
Shifts in Aggregate Demand
9
  • Aggregate Supply of Goods and Services

10
Aggregate Supply of Goods Services
  • When considering the Aggregate Supply curve, it
    is important to distinguish between the
    short-run and the long-run.
  • Short-run -- time period during which some
    prices, particularly those in resource
    markets, are set by prior contracts and
    agreements. Therefore, in the short-run,
    households and businesses are unable to adjust
    these prices when unexpected changes occur,
    including unexpected changes in the price
    level.
  • Long-run -- a time period of sufficient
    duration that people have the opportunity
    to modify their behavior in response to
    economic changes.

11
  • Short-Run Aggregate Supply (SRAS)

12
Short-Run Aggregate Supply (SRAS)
  • SRAS indicates the various quantities of goods
    services that domestic firms will supply in
    response to changing demand conditions that alter
    the level of prices in the goods services
    market.
  • SRAS curve slopes upward to the right.
  • The upward slope reflects the fact that in the
    short run an unanticipated increase in the price
    level will improve the profitability of firms and
    they will respond with an expansion in output.

13
Short-Run Aggregate Supply Curve
14
Shifts in Aggregate Supply
  • Factors that change SRAS
  • A change in resource costs such as wages, rent,
    and interest.
  • Unexpected supply shocks such as a change in
    weather or in the world price of a key imported
    resource.
  • A change in Taxes or Government Spending

15
Shifts in Short Run Aggregate Supply
16
  • Long-Run Aggregate Supply (LRAS)

17
Long-Run Aggregate Supply (LRAS)
  • LRAS indicates the relationship between the price
    level and quantity of output after decision
    makers have had sufficient time to adjust their
    prior commitments where possible.
  • LRAS curve is vertical.
  • LRAS is related to the economy's production
    possibilities frontier. A higher price level does
    not loosen the constraints imposed by the
    economy's resource base, level of technology, and
    the efficiency of its institutional arrangements.

18
Long-Run Aggregate Supply Curve
19
Shifts in Long Run Aggregate Supply
  • Factors that change LRAS
  • A change in the supply of resources.
  • A change in technology and productivity.
  • Institutional changes that change the efficiency
    of resource use such as trade agreements.

20
Shifts in Long RunAggregate Supply
  • Such factors as an increase in the stock of
    capital or an improvement in technology will
    expand the economys potential output and shift
    the LRAS to the right (note that SRAS will also
    shift to the right).
  • Such factors as a reduction in resource prices,
    favorable weather, or a temporary decrease in the
    world price of an important imported resource
    would shift SRAS to the right (note that LRAS
    will remain constant).

21
  • Anticipated and Unanticipated Changes

22
Anticipated and Unanticipated Changes
  • Anticipated changes are foreseen by economic
    participants.
  • Decision makers have time to adjust to them
    before they occur.
  • Unanticipated changes catch people by surprise.

23
  • Unanticipated Changes in Aggregate Demand

24
Unanticipated Changes in Aggregate Demand
  • Impact of unanticipated reductions in AD
  • Weak demand and lower prices in the goods
    services market will reduce profit margins. Many
    firms will incur losses.
  • Firms will reduce output, the rate of
    unemployment will rise above the natural rate,
    and output will temporarily fall short of the
    economy's long-run potential.
  • With time, long-term contracts will be modified.
  • Eventually, lower resource costs and a lower real
    interest rate will direct the economy back to
    long-run equilibrium, but this may be a lengthy
    and painful process.

25
Unanticipated Reduction in Aggregate Demand
  • The short-run impact of an unanticipated
    reduction in AD (shift from AD1 to AD2) will be a
    decline in output (decreases to Y2), and a lower
    price level (P95).
  • Temporarily, profit margins decline, output
    falls, and unemployment rises higher than the
    natural rate.

26
Unanticipated Reduction in Aggregate Demand
Price level
SRAS1
AD1
Goods Services(real GDP)
  • In the long-run, weak demand and excess supply in
    the resource market will lead to lower wage rates
    and resource prices resulting in an expansion in
    short-run aggregate supply to SRAS2.
  • In the long-run, a new equilibrium at a lower
    price level (P90) and an output consistent with
    the economys sustainable potential will result.
  • This method of restoring equilibrium may be both
    long and painful.

27
Unanticipated Changes in Aggregate Demand
  • Impact of unanticipated increases in AD
  • Initially, the strong demand and higher price
    level in the goods services market will
    temporarily improve profit margins.
  • Output will increase, the rate of unemployment
    will drop below the natural rate, and output will
    temporarily exceed the economy's long-run
    potential.
  • With time, however, contracts will be modified
    and resource prices will rise and return to their
    competitive relation with product prices.
  • Once this happens, output will recede to the
    economy's long-run potential.

28
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).

29
Unanticipated Increase in Aggregate Demand
Price level
SRAS1
AD2
AD1
Goods Services(real GDP)
  • With the passage of time, prices in resource
    markets, including the labor market, will rise
    due to the strong demand. As a result, higher
    costs reduce aggregate supply to SRAS2.
  • In the long-run, a new equilibrium at a higher
    price level (P110) and an output consistent with
    the economys sustainable potential will occur.
  • Thus, the increase in demand will expand output
    only temporarily.

30
  • Impact of Changes in Aggregate Supply

31
Impact of Changes in Aggregate Supply
  • Economic growth and anticipated shifts in
    long-run aggregate supply.
  • Increases in LRAS will make it possible to
    produce and sustain a larger rate of output.
  • Both LRAS and SRAS will shift to the right and
    output will increase.
  • These changes generally take place slowly and
    therefore they need not disrupt long-run
    equilibrium.

32
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).

33
  • The Business Cycle -- Revisited

34
The Business Cycle -- Revisited
  • Recessions occur because prices in the goods
    services market are low relative to the costs of
    production and resource prices.
  • The two causes of recessions
  • unanticipated reductions in aggregate demand,
    and,
  • unfavorable supply shocks.
  • An unsustainable economic boom occurs when prices
    in the goods services market are high relative
    to costs and resource prices.
  • The two causes of booms are
  • unanticipated increases in aggregate demand, and,
  • favorable supply shocks.

35
Expansions, Recessions, and the Rate of
Unemployment
  • Here we illustrate the periods of expansion
    and contraction (recession) since 1960.
  • Note how the reductions in real GDP (shaded
    periods) in the top graph are associated
    with increases in the rate of unemployment
    well above the natural rate (bottom graph).
  • The AD/AS model indicates that recessions are
    caused by unanticipated reductions in AD that are
    likely to accompany abrupt reductions in the
    inflation rate and/or adverse supply shocks that
    might occur, for example, when there is a large
    increase in the price of a key imported resource,
    such as crude oil.

36
  • Does the Market Have a Self-Corrective
    Mechanism That Will Keep it on Track?

37
Does the Market Have a Self-Corrective
Mechanism That Will Keep it on Track?
  • There are three reasons to believe that it does
  • Consumption demand is relatively stable over the
    business cycle.
  • Changes in real interest rates will help to
    stabilize aggregate demand and redirect economic
    fluctuations.
  • Interest rates will tend to fall during a
    recession and rise during and economic boom.
  • Changes in real resource prices will redirect
    economic fluctuations.
  • Real resource price will tend to fall during a
    recession and rise during an economic expansion.

38
Changes in Real Interest Rates and Resource
Prices Over the Business Cycle
Real interest rates fall (because of weak demand
for investment)
Real interest rates rise (because of
strongdemand for investment)
r
r
Real resource prices fall (because of weak demand
and high unemployment)
Real resource prices rise (because of strong
demand and low unemployment)
  • When aggregate output is less than the economys
    full employment potential (YF), weak demand for
    investment leads to lower real interest rates,
    while slack employment in resource markets will
    place downward pressure on wages and other
    resource prices (Pr).
  • Conversely, when output exceeds YF, strong demand
    for capital goods and tight labor market
    conditions will result in rising real interest
    rates and resource prices (Pr).

39
The Economys Self Corrective Mechanism
  • If output is temporarily less than capacity,
    lower interest rates (reflecting the weak demand
    for investment funds) will stimulate aggregate
    demand (shifting AD from AD1 to AD2).
  • In addition, lower resource prices will reduce
    production prices (because of weak demand and
    abnormally high unemployment) and thereby
    stimulate SRAS (shifting SRAS to SRAS2).
  • This output will move the economy toward
    full-employment capacity. However, this
    self-correction process may take some time.

40
The Economys Self Corrective Mechanism
  • If output is temporarily greater than the
    economys potential, higher real interest rates
    and resource prices will lead to a lower but
    sustainable rate of output.
  • Higher interest rates will reduce AD (from AD1 to
    AD2).
  • At the same time, higher resource prices will
    increase production costs and therefore reduce
    SRAS (from SRAS1 to SRAS2).
  • These forces direct output toward full-employment
    potential (YF).

41
  • The Great Debate -- How rapidly does
    the self-corrective mechanism work?

42
The Great Debate -- How rapidly does the
self-corrective mechanism work?
  • Many economists believe that the self-corrective
    mechanism works slowly.
  • If this is the case, then market economies will
    still experience prolonged periods of abnormally
    high unemployment and below-capacity output.
  • Others believe that the self-corrective mechanism
    works fairly rapidly if it is not disrupted by
    perverse monetary and fiscal policy.
  • This is an important and continuing debate that
    we will return to and analyze in more detail as
    we proceed.

43
EndChapter 13
About PowerShow.com