Aggregate Demand and Aggregate Supply

Transcription

1 Aggregate Demand and Aggregate Supply Chapter 19 Copyright 2001 by Harcourt, Inc. All rights reserved. Requests for permission to make copies of any part of the work should be mailed to: Permissions Department, Harcourt College Publishers, 6277 Sea Harbor Drive, Orlando, Florida

2 Short-Run Economic Fluctuations Economic activity fluctuates from year to year. In most years production of goods and services rises. On average over the past 50 years, production in the U.S. economy has grown by about 3 percent per year. In some years normal growth does not occur, causing a recession.

3 Short-Run Economic Fluctuations A recession is a period of declining real GDP, falling incomes, and rising unemployment. A depression is a severe recession.

4 Three Key Facts About Economic Fluctuations Economic fluctuations are irregular and unpredictable. Fluctuations in the economy are often called the business cycle. Most macroeconomic variables fluctuate together. As output falls, unemployment rises.

5 A Look At Short-Run Economic Fluctuations (a) Real GDP Recessions Billions of 1992 Dollars $7,000 6,500 Real GDP 6,000 5,500 5,000 4,500 4,000 3,500 3,000 2, Harcourt, Inc. items and derived items copyright 2001 by Harcourt, Inc.

6 Three Key Facts About Economic Fluctuations Most macroeconomic variables fluctuate together. Most macroeconomic variables that measure some type of income or production fluctuate closely together. Although many macroeconomic variables fluctuate together, they fluctuate by different amounts.

7 A Look At Short-Run Economic Fluctuations (b) Investment Spending Billions of 1992 Dollars $1,100 1, Harcourt, Inc. items and derived items copyright 2001 by Harcourt, Inc. Recessions Investment spending

8 Three Key Facts About Economic Fluctuations As output falls, unemployment rises. Changes in real GDP are inversely related to changes in the unemployment rate. During times of recession, unemployment rises substantially.

9 A Look At Short-Run Economic Fluctuations Percent of Labor Force (c) Unemployment Rate Recessions Unemployment rate Harcourt, Inc. items and derived items copyright 2001 by Harcourt, Inc.

10 How the Short Run Differs From the Long Run Most economists believe that classical theory describes the world in the long run but not in the short run. Changes in the money supply affect nominal variables but not real variables in the long run. The assumption of monetary neutrality is not appropriate when studying year-to-year changes in the economy.

11 The Basic Model of Economic Fluctuations Two variables are used to develop a model to analyze the short-run fluctuations. The economy s output of goods and services measured by real GDP. The overall price level measured by the CPI or the GDP deflator.

12 The Basic Model of Economic Fluctuations Economist use the model of aggregate demand and aggregate supply to explain short-run fluctuations in economic activity around its long-run trend.

13 The Basic Model of Economic Fluctuations The aggregate demand curve shows the quantity of goods and services that households, firms, and the government want to buy at each price level.

14 The Basic Model of Economic Fluctuations The aggregate supply curve shows the quantity of goods and services that firms produce and sell at each price level.

15 Aggregate Demand and Aggregate Supply... Price Level Aggregate supply Equilibrium price level Aggregate demand 0 Equilibrium output Harcourt, Inc. items and derived items copyright 2001 by Harcourt, Inc. Quantity of Output

16 The Aggregate Demand Curve The four components of GDP (Y) contribute to the aggregate demand for goods and services. Y = C + I + G + NX

17 The Aggregate-Demand Curve... Price Level P 1 1. A decrease in the price level... P 2 Aggregate demand 0 Harcourt, Inc. items and derived items copyright 2001 by Harcourt, Inc. Y 1 Y 2 2. increases the quantity of goods and services demanded. Quantity of Output

18 Why the Aggregate Demand Curve Is Downward Sloping The Price Level and Consumption: The Wealth Effect The Price Level and Investment: The Interest Rate Effect The Price Level and Net Exports: The Exchange-Rate Effect

19 The Price Level and Consumption: The Wealth Effect A decrease in the price level makes consumers feel more wealthy, which in turn encourages them to spend more. This increase in consumer spending means larger quantities of goods and services demanded.

20 The Price Level and Investment: The Interest Rate Effect A lower price level reduces the interest rate, which encourages greater spending on investment goods. This increase in investment spending means a larger quantity of goods and services demanded.

21 The Price Level and net Exports: The Exchange-Rate Effect When a fall in the U.S. price level causes U.S. interest rates to fall, the real exchange rate depreciates, which stimulates U.S. net exports. The increase in net export spending means a larger quantity of goods and services demanded.

22 Why the Aggregate Demand Curve Might Shift The downward slope of the aggregate demand curve shows that a fall in the price level raises the overall quantity of goods and services demanded. Many other factors, however, affect the quantity of goods and services demanded at any given price level. When one of these other factors changes, the aggregate demand curve shifts.

23 Why the Aggregate Demand Curve Might Shift Shifts arising from Consumption Shifts arising from Investment Shifts arising from Government Purchases Shifts arising from Net Exports

24 Price Level Shifts in the Aggregate Demand Curve... P 1 D 2 Aggregate demand, D 1 0 Y 1 Harcourt, Inc. items and derived items copyright 2001 by Harcourt, Inc. Y 2 Quantity of Output

25 The Aggregate Supply Curve In the long run, the aggregatesupply curve is vertical. In the short run, the aggregatesupply curve is upward sloping.

26 The Long-Run Aggregate Supply Curve In the long-run, an economy s production of goods and services depends on its supplies of labor, capital, and natural resources and on the available technology used to turn these factors of production into goods and services. The price level does not affect these variables in the long run.

27 The Long-Run Aggregate- Supply Curve... Price Level P 1 Long-run aggregate supply 1. A change in the price level P 2 0 Natural rate of output Harcourt, Inc. items and derived items copyright 2001 by Harcourt, Inc. 2. does not affect the quantity of goods and services supplied in the long run. Quantity of Output

28 The Long-Run Aggregate Supply Curve The long-run aggregate supply curve is vertical at the natural rate of output. This level of production is also referred to as potential output or full-employment output.

29 Why the Long-Run Aggregate Supply Curve Might Shift Any change in the economy that alters the natural rate of output shifts the longrun aggregate-supply curve. The shifts may be categorized according to the various factors in the classical model that affect output.

30 Why the Long-Run Aggregate Supply Curve Might Shift Shifts arising from Labor Shifts arising from Capital Shifts arising from Natural Resources Shifts arising from Technological Knowledge

31 Long-Run Growth and Inflation and ongoing inflation. Price Level P 2000 P and growth in the money supply shifts aggregate-demand... LRAS 1980 LRAS 1990 LRAS In the longrun, technological progress shifts long-run aggregate supply... P 1980 AD Y 1980 Harcourt, Inc. items and derived items copyright 2001 by Harcourt, Inc. AD 1980 AD 1990 Y 1990 Y leading to growth in output... Quantity of Output

32 Long-Run Growth and Inflation Short-run fluctuations in output and price level should be viewed as deviations from the continuing longrun trends.

33 Why the Short-Run Aggregate Supply Curve Slopes Upward in the Short Run In the short run, an increase in the overall level of prices in the economy tends to raise the quantity of goods and services supplied. A decrease in the level of prices tends to reduce the quantity of goods and services supplied.

34 The Short-Run Aggregate Supply Curve... Price Level Short-run aggregate supply P 1 1. A decrease in the price level P 2 2. reduces the quantity of goods and services supplied in the short run. Y 2 Harcourt, Inc. items and derived items copyright 2001 by Harcourt, Inc. 0 Y 1 Quantity of Output

35 Why the Short-Run Aggregate Supply Curve Slopes Upward in the Short Run The Misperceptions Theory The Sticky-Wage Theory The Sticky-Price Theory

36 The Misperceptions Theory Changes in the overall price level temporarily mislead suppliers about what is happening in the markets in which they sell their output: A lower price level causes misperceptions about relative prices. These misperceptions induce suppliers to decrease the quantity of goods and services supplied.

37 The Sticky-Wage Theory Nominal wages are slow to adjust, or are sticky in the short run: Wages do not adjust immediately to a fall in the price level. A lower price level makes employment and production less profitable. This induces firms to reduce the quantity of goods and services supplied.

38 The Sticky-Price Theory Prices of some goods and services adjust sluggishly in response to changing economic conditions: An unexpected fall in the price level leaves some firms with higher-than-desired prices. This depresses sales, which induces firms to reduce the quantity of goods and services they produce.

39 Why the Aggregate Supply Curve Might Shift Shifts arising from Labor Shifts arising from Capital Shifts arising from Natural Resources. Shifts arising from Technology. Shifts arising from the Expected Price Level.

40 Why the Aggregate Supply Curve Might Shift An increase in the expected price level reduces the quantity of goods and services supplied and shifts the short-run aggregate supply curve to the left. A decrease in the expected price level raises the quantity of goods and services supplied and shifts the short-run aggregate supply curve to the right.

41 The Long-Run Equilibrium Price Level Long-run aggregate supply Short-run aggregate supply Equilibrium price A 0 Harcourt, Inc. items and derived items copyright 2001 by Harcourt, Inc. Natural rate of output Aggregate demand Quantity of Output

42 A Contraction in Aggregate Demand... Price Level P 1 P 2 P causes output to fall in the short run Long-run aggregate supply Y 2 B Y 1 A C Short-run aggregate supply, AS 1 AD 2 4. and output returns to its natural rate. AS 2 3. but over time, the short-run aggregate-supply curve shifts 1. A decrease in aggregate demand Aggregate demand, AD 1 Quantity of Output

43 Shifts in Aggregate Demand In the short run, shifts in aggregate demand cause fluctuations in the economy s output of goods and services. In the long run, shifts in aggregate demand affect the overall price level but do not affect output.

44 An Adverse Shift in Aggregate Supply A decrease in one of the determinants of aggregate supply shifts the curve to the left: Output falls below the natural rate of employment. Unemployment rises. The price level rises.

45 An Adverse Shift in Aggregate Supply... Price Level Long-run aggregate supply 1. An adverse shift in the short-run aggregate-supply curve AS 2 Short-run aggregate supply, AS 1 P 2 P 1 3. and the price level to rise. 0 B A Y 2 Y 1 2. causes output to fall Aggregate demand Quantity of Output

46 Stagflation Adverse shifts in aggregate supply cause stagflation a combination of recession and inflation. Output falls and prices rise. Policymakers who can influence aggregate demand cannot offset both of these adverse effects simultaneously.

47 Policy Responses to Recession Policymakers may respond to a recession in one of the following ways: Do nothing and wait for prices and wages to adjust. Take action to increase aggregate demand by using monetary and fiscal policy.

48 Accommodating an Adverse Shift in Aggregate Supply... Price Level 1. When short-run aggregate supply falls Long-run aggregate supply AS 2 Short-run aggregate supply, AS 1 P 3 P 2 P 1 A C 2. policymakers can accommodate the shift by expanding aggregate demand 3...which causes the price level to rise 0 4. but keeps output at its natural rate. Natural rate of output Harcourt, Inc. items and derived items copyright 2001 by Harcourt, Inc. AD 2 Aggregate demand, AD 1 Quantity of Output

49 The Effects of a Shift in Aggregate Supply Shifts in aggregate supply can cause stagflation a combination of recession and inflation. Policymakers who can influence aggregate demand cannot offset both of these adverse effects simultaneously.

50 Summary All societies experience short-run economic fluctuations around long-run trends. These fluctuations are irregular and largely unpredictable. When recessions occur, real GDP and other measures of income, spending, and production fall, and unemployment rises.

51 Summary Economists analyze short-run economic fluctuations using the aggregate demand and aggregate supply model. According to the model of aggregate demand and aggregate supply, the output of goods and services and the overall level of prices adjust to balance aggregate demand and aggregate supply.

52 Summary The aggregate-demand curve slopes downward for three reasons: a wealth effect, an interest rate effect, and an exchange rate effect. Any event or policy that changes consumption, investment, government purchases, or net exports at a given price level will shift the aggregate-demand curve.

53 Summary In the long run, the aggregate supply curve is vertical. The short-run, the aggregate supply curve is upward sloping. The are three theories explaining the upward slope of short-run aggregate supply: the misperceptions theory, the sticky-wage theory, and the sticky-price theory.

54 Summary Events that alter the economy s ability to produce output will shift the short-run aggregate-supply curve. Also, the position of the short-run aggregate-supply curve depends on the expected price level. One possible cause of economic fluctuations is a shift in aggregate demand.

55 Summary A second possible cause of economic fluctuations is a shift in aggregate supply. Stagflation is a period of falling output and rising prices.

56 Graphical Review

57 A Look At Short-Run Economic Fluctuations (a) Real GDP Recessions Billions of 1992 Dollars $7,000 6,500 Real GDP 6,000 5,500 5,000 4,500 4,000 3,500 3,000 2, Harcourt, Inc. items and derived items copyright 2001 by Harcourt, Inc.

58 A Look At Short-Run Economic Fluctuations (b) Investment Spending Billions of 1992 Dollars $1,100 1, Harcourt, Inc. items and derived items copyright 2001 by Harcourt, Inc. Recessions Investment spending

59 A Look At Short-Run Economic Fluctuations Percent of Labor Force (c) Unemployment Rate Recessions Unemployment rate Harcourt, Inc. items and derived items copyright 2001 by Harcourt, Inc.

60 Aggregate Demand and Aggregate Supply... Price Level Aggregate supply Equilibrium price level Aggregate demand 0 Equilibrium output Harcourt, Inc. items and derived items copyright 2001 by Harcourt, Inc. Quantity of Output

61 The Aggregate-Demand Curve... Price Level P 1 1. A decrease in the price level... P 2 Aggregate demand 0 Harcourt, Inc. items and derived items copyright 2001 by Harcourt, Inc. Y 1 Y 2 2. increases the quantity of goods and services demanded. Quantity of Output

62 Price Level Shifts in the Aggregate Demand Curve... P 1 D 2 Aggregate demand, D 1 0 Y 1 Harcourt, Inc. items and derived items copyright 2001 by Harcourt, Inc. Y 2 Quantity of Output

63 The Long-Run Aggregate- Supply Curve... Price Level P 1 Long-run aggregate supply 1. A change in the price level P 2 0 Natural rate of output Harcourt, Inc. items and derived items copyright 2001 by Harcourt, Inc. 2. does not affect the quantity of goods and services supplied in the long run. Quantity of Output

64 Long-Run Growth and Inflation and ongoing inflation. Price Level P 2000 P and growth in the money supply shifts aggregate-demand... LRAS 1980 LRAS 1990 LRAS In the longrun, technological progress shifts long-run aggregate supply... P 1980 AD Y 1980 Harcourt, Inc. items and derived items copyright 2001 by Harcourt, Inc. AD 1980 AD 1990 Y 1990 Y leading to growth in output... Quantity of Output

65 The Short-Run Aggregate Supply Curve... Price Level Short-run aggregate supply P 1 1. A decrease in the price level P 2 2. reduces the quantity of goods and services supplied in the short run. Y 2 Harcourt, Inc. items and derived items copyright 2001 by Harcourt, Inc. 0 Y 1 Quantity of Output

66 The Long-Run Equilibrium Price Level Long-run aggregate supply Short-run aggregate supply Equilibrium price A 0 Harcourt, Inc. items and derived items copyright 2001 by Harcourt, Inc. Natural rate of output Aggregate demand Quantity of Output

67 A Contraction in Aggregate Demand... Price Level P 1 P 2 P causes output to fall in the short run Long-run aggregate supply Y 2 B Y 1 A C Short-run aggregate supply, AS 1 AD 2 4. and output returns to its natural rate. AS 2 3. but over time, the short-run aggregate-supply curve shifts 1. A decrease in aggregate demand Aggregate demand, AD 1 Quantity of Output

68 An Adverse Shift in Aggregate Supply... Price Level Long-run aggregate supply 1. An adverse shift in the short-run aggregate-supply curve AS 2 Short-run aggregate supply, AS 1 P 2 P 1 3. and the price level to rise. 0 B A Y 2 Y 1 2. causes output to fall Aggregate demand Quantity of Output

69 Accommodating an Adverse Shift in Aggregate Supply... Price Level 1. When short-run aggregate supply falls Long-run aggregate supply AS 2 Short-run aggregate supply, AS 1 P 3 P 2 P 1 A C 2. policymakers can accommodate the shift by expanding aggregate demand 3...which causes the price level to rise 0 4. but keeps output at its natural rate. Natural rate of output Harcourt, Inc. items and derived items copyright 2001 by Harcourt, Inc. AD 2 Aggregate demand, AD 1 Quantity of Output