LECTURE 20 LAST TIME Aggregate Demand & Aggregate Supply together again for the first time. Aww. NEWS. TODAY. Aggregate Demand & Supply in a Crisis

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1 Aggregate Demand & Supply in a Crisis LECTURE 20 LT TIME Aggregate Demand & Aggregate Supply together again for the first time. Aww. NEWS. TODAY. Aggregate Supply & Aggregate Demand Effects. Fiscal Policy; Automatic Stabilisers; Multiplier & Crowding out effects; AIB Payments Deal. Worst. Minister. Ever. (FT) NTMA said it sold!200m of a 2014 bond at a bid-cover-ratio of 7.9, with an!800m sale of a 2019 bond also well bid at 2.5 times. Raised 1bn this week. Irish Life & Permanent says new lending down 80%.

2 FROM LT TIME SR. Because you asked for it. AGGREGATE SUPPLY SR 1 SR SR 2 Short run aggregate supply (SR) assumes firms only able to increase output at higher costs (e.g. overtime payments) thereby pushing up price level SR assumes costs such as overall wage rate remain fixed, changes in such costs cause a shift in the SR curve (exogenous shocks input costs) 2.5% PUTTING AND TOGETHER A shift in the curve to In 1 this as situation, a result of the a change economy in any would or all be of the operating factors at affecting less than capacity, would increase there would growth, be unemployment reduce unemployment and the but economy at a cost might of higher be inflation growing only (a trade-off) slowly. 1

3 3.5% 2.5% Putting and together Further increases in would lead to successively smaller increases in growth and employment at the cost of ever higher inflation. 2 SUSTAINED GROWTH 1 Sustained growth (not to be confused with sustainable economic growth) occurs when and rise at similar rates national income can rise without effects on inflation 1 Y HOW FISCAL POLICY INFLUENCES AGGREGATE DEMAND Fiscal policy refers to the government s choices regarding the overall level of government purchases or taxes. Fiscal policy influences saving, investment, and growth in the long run. In the short run, fiscal policy primarily affects the aggregate demand. Fiscal policy can be used to alter government purchases or to change taxes.

4 CHANGES IN GOVERNMENT PURCHES Price Level THE MULTIPLIER EFFECT 2. but the multiplier effect can amplify the shift in aggregate demand. There are two macroeconomic effects from the change in government purchases:! The multiplier effect The crowding-out effect 0!20 billion 1. An increase in government purchases of!20 billion initially increases aggregate demand by!20 billion 2 Aggregate demand, 1 Quantity of Output 3 THE CROWDING-OUT EFFECT AUTOMATIC STABILIZERS Fiscal policy may not affect the economy as strongly as predicted by the multiplier. An increase in government purchases causes the interest rate to rise. A higher interest rate reduces investment spending. Automatic stabilizers are changes in fiscal policy that stimulate aggregate demand when the economy goes into a recession without policymakers having to take any deliberate action. Automatic stabilizers include the tax system and some forms of government spending.

5 INFLATION. 1 COST PUSH Economy in eqm at, 2% inflation. Costs go up, shifts to 1. Cost push. Rise in the general price level resulting from an increase in the cost of production Demand pull. Rise in the general price level resulting from an excess of total spending 2.3% DEMAND PULL FOR TOMORROW: Economy in eqm at, 2% inflation. Increase in spending pushes to 1 2.5% 2 What happens when we experience a decrease in both and? Deflation.

6 Decrease in price level. Deflation. Decrease in real GDP WRITE DOWN 2 THINGS YOU REMEMBER FROM TODAY. Decrease in aggregate demand and supply SUMMARY Aggregate Demand & Aggregate Supply Fiscal Policy