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Aggregate Demand and Aggregate Supply

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Aggregate Demand and Aggregate Supply Chapter 12 – PowerPoint PPT presentation

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Title: Aggregate Demand and Aggregate Supply


1
Aggregate Demand and Aggregate Supply
  • Chapter 12

2
Aggregate Demand (AD)
  • Shows the relationship between the aggregate
    price level and the quantity of aggregate output
    demanded by households, businesses, government,
    and the rest of the world.
  • Is negatively sloped because the aggregate price
    level is inversely related to the quantity of
    aggregate output demanded.
  • AD C I G Xn

3
Two Definitions
  • The wealth effect of a change in the aggregate
    price level is the effect on consumer spending
    caused by the effect of a change in the aggregate
    price level on the purchasing power of consumers
    assets.
  • Higher prices reduces purchasing power
    negative slope.
  • The interest rate effect of a change in the
    aggregate price level is the effect on investment
    spending and consumer spending caused by the
    effect of a change in the aggregate price level
    on the purchasing power of consumers and firms
    money holdings.
  • Higher prices reduce purchasing power of consumer
    and business money holdings which leads to a rise
    in interest rate which causes investment spending
    to decrease negative slope.

4
Aggregate Demand Curve
5
Shifts of Aggregate Demand (AD)
  • ANYTHING THAT CHANGES C I G Xn
  • CHANGES IN EXPECTATIONS
  • Impacts both businesses and individuals
  • Rosy future greater spending
  • Gloomy future less spending
  • CHANGES in WEALTH Other than PRICE LEVEL
  • Stock market rises or falls
  • Real estate rises or falls
  • CHANGES IN INVESTMENT SPENDING ON PHYSICAL
    CAPITALS

6
Shifts in Aggregate Demand (AD)
7
Government Policies and Aggregate Demand
  • Key insights of macroeconomics is that government
    can have a powerful influence on aggregate
    demand thus, improving economic performance.
  • Fiscal Policy
  • Directly through government spending level
    (purchases) increases or decreases
  • Indirectly through changes in taxes or government
    transfers-increases or decreases
  • Monetary Policy
  • Indirectly, through changes in the interest rate

8
Changes in Aggregate Demand (AD)
  • Optimistic about the future
  • When the stock market declines
  • When the government reduces spending or raises
    taxes
  • When the central bank increases the quantity of
    money

Price level
AD2
AD1
AD3
Real domestic output, GDP
9
Aggregate Supply Curve
  • Shows the relationship between the aggregate
    price level and the quantity of aggregate output
    supplied.
  • Shows real domestic OUTPUT (GDP) produced at each
    price level.
  • Businesses will produce more output at a higher
    price level than they will at a lower price
    level.

10
Aggregate Supply
  • Changes in the price level bring about changes in
    the quantity of AS (movement along the AS
    curve.)
  • Two different AS curves
  • SHORT RUN AGGREGATE SUPPLY CURVE (SRAS)
  • LONG RUN AGGREGATE SUPPLY CURVE (LRAS)

11
Short Run Aggregate Supply (SRAS)
  • Shows the relationship between the aggregate
    price level and the quantity of aggregate output
    supplied that exists in the short run, the period
    when many productions costs can be taken as
    fixed.
  • Positively sloped because as the aggregate price
    level increases and wages remain sticky, it
    become more profitable for firms to supply more
    output.
  • Wages are assumed sticky or inflexible due to
    labor contracts or informal wage agreements that
    business are reluctant to change in response to
    short-run fluctuations.

12
Short Run Aggregate Supply (SRAS)
13
Shifts in Short-Run Aggregate Supply (SRAS)
  • Short-run aggregate supply increases when
    producers increase the quantity of aggregate
    output they are willing to supply at any given
    price level.
  • An increase in short-run aggregate supply is
    demonstrated by a rightward shift of the SRAS.
  • SRAS increases
  • Commodity prices (input) fall
  • Nominal wages fall
  • Productivity rises
  • Other factors change that decrease firms costs of
    production

Tax Subsidy
14
Shifts in Short-Run Aggregate Supply (SRAS)
  • Short-run aggregate supply decreases when
    producers decrease the quantity of aggregate
    output they are willing to supply at any given
    price level.
  • An decrease in short-run aggregate supply is
    demonstrated by a leftward shift of the SRAS.
  • SRAS decreases
  • Commodity (input) prices rise
  • Nominal wages rise
  • Productivity falls
  • Other factors change that increase firms costs of
    production

Closing of Loopholes
15
Shifts in SRAS
16
Shifts in SRAS
SRAS3
SRAS1
  • Price of oil declines
  • Home mortgage tax deduction is eliminated
  • An earthquake destroys a significant amount of
    infrastructure in the economy.
  • Technological progress occurs in the economy.

SRAS2
Price level
Real domestic output, GDP
17
Long-Run Aggregate Supply (LRAS)
  • Shows the relationship between the aggregate
    price level and the quantity of aggregate output
    supplied that would exist if all prices,
    including nominal wages, were fully flexible.
  • Is vertical because changes in the aggregate
    price level have no effect on aggregate output in
    the long run.
  • Wave a magic wand and cut ALL Prices in half.
  • Lower prices for product but also lower costs.

18
Long-Run Aggregate Supply (LRAS)
Potential output is the level of real GDP the
economy would produce if all prices, including
nominal wages were fully flexible.
19
Shifts in LRAS
  • US potential output has risen over time due to
    increases in
  • Physical capital
  • Human capital
  • Technological progress

20
From Short-Run to Long-Run
  • The economy maybe operating on a SRAS or on LRAS
    at any time.
  • Might be operating on both if the level of output
    in the SRAS and LRAS intersect.

21
AS-AD Model
  • The economy is in short-run macroeconomic
    equilibrium when the quantity of aggregate output
    supplied is to the quantity demanded.
  • Price equilibrium
  • Output equilibrium

22
Shifts of Aggregate Demand Short-Run Effects
  • An event that shifts the aggregate demand curve
    is a demand shock.
  • A negative demand shock shifts the aggregate
    demand curve to the left.
  • Price level falls and equilibrium level of
    aggregate output decreases.

Collapse of busines or consumer confidence
23
Shifts of Aggregate Demand Short-Run Effects
  • A positive demand shock shifts the aggregate
    demand curve to the right.
  • Price level increases and equilibrium level of
    aggregate output increases.

Increase in consumer spending
24
Shifts of SRAS Curve
  • An event that shifts the short-run aggregate
    supply curve is a supply shock.
  • A negative supply shock, which increases firms
    cost of products shifts the SRAS curve to the
    left.
  • Increased price level and decrease in equilibrium
    output.

25
Negative Supply Shocks
26
Negative Supply Shocks Price of Oil
27
Shifts of SRAS Curve
  • A positive supply shock, which decreases firms
    cost of products, shifts the SRAS curve to the
    right.
  • Decreased price level and increase in equilibrium
    output.

28
Long-Run Macro Equilibrium
  • The economy is in long-run macro equilibrium when
    the point of short-run macro equilibrium is on
    the long-run aggregate supply curve.

29
Short-run vs Long-run Effects of a Negative
Demand Shock
  • There is a recessionary gap when aggregate output
    is below potential output.
  • In the long run, the economy is self-correcting.

30
Short-run vs Long-run Effects of a Positive
Demand Shock
  • There is a inflationary gap when aggregate output
    is above potential output.
  • In the long run, the economy is self-correcting.

31
Macroeconomic Policy
  • Stabilization policy is the use of monetary or
    fiscal policy to offset demand shocks.
  • Stabilization policy can lead to a long-run rise
    in the budget deficit and lower long-run growth
    from crowding out.
  • Macroeconomic policies that are used to
    counteract a fall in aggregate output caused by a
    negative supply shock will lead to higher
    inflation.
  • A macro policy that counteracts inflation by
    reducing aggregate demand will deepen a recession
    or depression.
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