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Aggregate Demand and Aggregate Supply

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Title: Aggregate Demand and Aggregate Supply


1
  • Aggregate Demand and Aggregate Supply

2
The Aggregate Demand Curve
  • When price level rises, money demand curve shifts
    rightward
  • Consequently, interest rate is higher, given
    money supply is fixed
  • Then, aggregate expenditure decreases (AE line
    shifts downward)
  • As a result, the equilibrium GDP becomes lower
  • So,
  • a rise in price level causes a decrease in
    equilibrium GDP.
  • The aggregate demand curve shows the
    negative relationship between price levels and
    equilibrium real GDP

3
Figure 1 Deriving the Aggregate Demand Curve
4
Understanding the AD Curve
  • Each point on the AD curve represents a short-run
    equilibrium in economy
  • The AD curve is different from a demand curve for
    one particular product

5
Movements of the AD Curve
  • Moving along the AD curve whenever price level
    changes
  • When anything other than price level cause
    equilibrium GDP to change, the AD curve shifts
  • Government purchasing
  • Taxes
  • Autonomous consumption spending
  • Investment spending
  • Net exports
  • Money supply
  • Expectations

6
Figure 2 A Spending Shock Shifts the AD Curve
7
Costs and Prices
  • To understand how macroeconomic events affect the
    price level, we assume
  • A firm sets price of its products as a markup
    over cost per unit
  • So, in the short-run, price level rises when
    there is an economy-wide increase in unit costs
  • Labor costs
  • Costs of natural resources
  • How an increase in output level raises the price
    level?
  • As output increases, demand for inputs rises
  • As unit cost increases, price level ( assumed as
    a markup over unit cost) rises

8
Figure 3 The Aggregate Supply Curve
9
Movements of the AS Curve
  • When price level changes due to a change in real
    GDP, the change happens along the AS curve
  • When the change of price level is caused by any
    factor other than real GDP, the AS curve shifts
  • Oil prices
  • Weather
  • Technological change
  • Nominal wage

10
Figure 4 Shifts of the Aggregate Supply Curve
11
Figure 5 Short-Run Macroeconomic Equilibrium
12
Figure 6 The Effect of a Demand Shock
13
An Increase in Government Purchases
  • When G , AD curve shifts rightward. As a
    result, real GDP , given price level is fixed
  • However, when real GDP , unit cost , so price
    level
  • Furthermore, as price level , Md and interest
    rate , which causes aggregate expenditure to
    decrease
  • In the end, real GDP increases by less than
    horizontal shift in AD curve

14
An Increase in the Money Supply
  • Can you demonstrate how an increase in the money
    supply affects the real equilibrium GDP?

15
Demand Shocks
  • A positive demand shockshifts AD curve rightward
  • Increases both real GDP and price level in
    short-run
  • A negative demand shockshifts AD curve leftward
  • Reduces both real GDP and price level in short-run

16
Examples
  • The Great Depression 1929 1933
  • Negative demand shocks
  • Oil Crisis 1973 (began on October 17)
  • Negative supply shocks

17
Demand Shocks Adjusting to the Long-Run
  • In short-run, wage rate is treated as given
  • But in long-run, wage rate can change
  • When output is above full employment, wage rate
    will rise, shifting AS curve upward
  • When output is below full employment, wage rate
    will fall, shifting AS curve downward

18
Figure 7 The Long-Run Adjustment Process After
A Positive Demand Shock
19
Figure 8 Long-Run Adjustment After A Negative
Demand Shock
20
Figure 9 The Effect of a Supply Shock
21
More examples
  • 1990-91 recession
  • Oil supplies and price of oil
  • 2001 recession
  • Money supply and interest rate

22
Inflation and Unemployment
  • Low inflation and unemployment
  • Feds major goals
  • Compatible or conflicting?
  • Short-run tradeoff
  • Supply shocks cause both rates to rise
  • No long-run tradeoff

23
The Phillips Curve
AS
P3
Price Level
P2
AD3
P1
AD2
P0
AD1
AD0
0
Q0
Q1
Q2
Q3
Real Domestic Output
24
The Phillips Curve
  • Demonstrates short-run tradeoff between inflation
    and unemployment

Concept
Empirical Data Data for the 1960s
69
68
66
67
65
63
62
61
64
25
The Phillips Curve
  • No long-run tradeoff between inflation and
    unemployment
  • Short-run Phillips curve
  • Role of expected inflation
  • Long-run vertical Phillips curve
  • Disinflation vs. Reflation

26
The Long Run Phillips Curve
PCLR
PC3
b3
PC2
a3
Annual Rate of Inflation (Percent)
b2
PC1
a2
c3
b1
a1
c2
0
Unemployment Rate (Percent)
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