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Aggregate Demand and Aggregate Supply

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Aggregate Demand and Aggregate Supply Read Chapter 7 pages 145-165 I Aggregate Demand A) Basic definitions Aggregate demand is the relationship between the total ... – PowerPoint PPT presentation

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Title: Aggregate Demand and Aggregate Supply


1
  • Aggregate Demand and Aggregate Supply
  • Read Chapter 7 pages 145-165
  • I Aggregate Demand
  • A) Basic definitions
  • Aggregate demand is the relationship between the
    total quantity of goods and services demanded and
    the price level, all other determinants of
    spending unchanged.
  • 2) The aggregate demand curve is a graphical
    representation of aggregate demand.

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  • B) The slope of the aggregate demand curve is
    negative. This reflects the following effects.
  • The wealth effect is the tendency for a change in
    the price level to affect real wealth and thus
    alter consumption.
  • The interest rate effect is the tendency for a
    change in the price level to affect the interest
    rate and thus the quantity of investment
    demanded.
  • 3) The international trade effect is the
    tendency for a change in the price level to
    affect net exports.

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  • C) Change in the quantity demanded versus a
    change in demand
  • A movement along an aggregate demand curve is a
    change in the aggregate quantity of goods and
    services demanded.
  • 2) A change in the aggregate quantity of goods
    and services demanded at every price level is a
    change in aggregate demand.

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  • D) Factors that can change aggregate demand.
  • Changes due to consumption
  • Consumer confidence.
  • Tax and transfer policy.
  • 2) Changes due to investment
  • Expectations about profits for firms.
  • b) Changes in interest rates due to things other
    than a change in the general price level. (I.e.
    not the same as the interest rate effect.)

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  • 3) Changes in government purchases.
  • 4) Changes in exports.
  • Change in a foreign countries income
  • Change in the exchange rate.
  • A countries exchange rate is the price of
    its currency in terms of another currency or
    currencies, e.g. yen/. A rise in the exchange
    rate makes U.S. goods more expensive and fewer
    are purchased.

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  • E) The multiplier
  • The multiplier is the ratio of the change in the
    quantity of real GDP demanded at each price
    level to the initial change in one or more
    components of aggregate demand that produce it.
  • Multiplier
  • change in real demand / initial change in
    demand component
  • 3) The multiplier occurs due to a domino effect.

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  • II Aggregate Demand and Aggregate Supply
  • Basics of the long run and the short run.
  • The short run in macroeconomic analysis is a
    period in which wages and some other prices do
    not respond to changes in economic conditions.
  • 2) A sticky price is a price that is slow to
    adjust to its equilibrium level, creating
    sustained periods of shortage or surplus.
  • 3) The long run in macroeconomic analysis is a
    period in which wages and prices are flexible.

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  • B) The long run
  • The long-run aggregate supply (LRAS) curve
    relates the level of output produced by firms to
    the price level in the long run.
  • This curve is vertical at the economys potential
    output level.
  • 3) Note, although there is a single real wage
    that clears the labor market, the price level and
    the nominal wage rate can take a range of values.

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  • 3) The long run equilibrium occurs where the long
    run aggregate supply and the aggregate demand
    curves intersect.

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  • C) The Short Run
  • The short-run aggregate supply (SRAS) curve is a
    graphical representation of the relationship
    between production and the price level in the
    short run.
  • 2) Factors held constant in the short run
  • Capital stock.
  • Stock of natural resources.
  • Level of technology.
  • d) Prices of factors of production.

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  • 3) A change in the price level produces a change
    in the aggregate quantity of goods and services
    supplied and is illustrated by the movement along
    the short-run aggregate supply curve.
  • 4) A change in the quantity of goods and services
    supplied at every price level in the short run is
    a change in short-run aggregate supply.

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  • D) Reasons for Wage and Price Stickiness
  • Wage Stickiness due to
  • labor contracts
  • minimum wages.
  • 2) Price Stickiness due to
  • induced from labor stickiness
  • reluctance by a firm to jeopardize customer
    relations
  • c) long term contracts.

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  • E) Equilibrium Levels of Price and Output in the
    short run.
  • Two examples
  • 1) A change in health care costs.

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  • 2) A change in government purchases.

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  • III Recessionary and Inflationary Gaps and the
    Achievement of Long-Run Macroeconomic Equilibrium
  • Terminology
  • The gap between the level of real GDP and
    potential output, when real GDP is less than
    potential, is called a recessionary gap.
  • 2) The gap between the level of real GDP and
    potential output, when real GDP is greater than
    potential, is called an inflationary gap.

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  • B) Restoring Long Run Macroeconomic Equilibrium
  • 1) An increase in Aggregate Demand.
  • a) Consider an economy initially at long run
    equilibrium given by subscripts of 1.
  • b) Next, suppose government spending increases.

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  • 2) A decrease in Aggregate Supply
  • Consider an economy initially at long run
    equilibrium given by subscripts of 1.
  • b) Next, suppose that health care costs rise.

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  • C) Gaps and Public Policy
  • A nonintervention policy is one in which there is
    no policy choice taken to try to close a
    recessionary or an inflationary gap.
  • 2) A stabilization policy is one in which a
    policy choice is taken in an attempt to move the
    economy to its potential output.
  • 3) A stabilization policy designed to increase
    real GDP is known as expansionary policy.
  • 4) A stabilization policy designed to reduce real
    GDP is a contractionary policy.

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  • 5) Fiscal policy is the use of government
    purchases, transfer payments and taxes to
    influence the level of economic activity.
  • 6) Monetary policy is the use of central bank
    policies to influence the level of economic
    activity.

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