Sticky Wages and Prices: Aggregate Expenditure and the Multiplier. 5Topic

Transcription

1 Sticky Wages and Prices: Aggregate Expenditure and the Multiplier 5Topic

2 Questioning the Classical Position and the Self-Regulating Economy John Maynard Keynes, an English economist, changed how many economists viewed the economy. Keynes s major work, The General Theory of employment, Interest and Money, was published in Just prior to its publication, the Great Depression had plagued many countries of the world. Unemployment was sky-high in many countries, and many economies had been contracting.

3 Questioning the Classical Position and the Self-Regulating Economy Where was Say s law, with its promise that there would be no general gluts? When was the self-regulating economy going to heal itself of its depression illness? Where was full employment? And, given the depressed state of the economy, could anyone any longer believe that laissez-faire was the right policy?

4 Questioning the Classical Position and the Self-Regulating Economy With the Great Depression as recent history, Keynes and the Keynesians thought that although their theory might not be right in every detail, they certainly had enough evidence to say that the classical view of the economy was wrong. Keynes challenged all four of the following classical position beliefs: (1) Say s law holds, so that insufficient demand in the economy is unlikely. (2) Wages, prices, and interest rates are flexible. (3) The economy is self-regulating. (4) Laissez-faire is the right and sensible economic policy.

5 Keynes s Criticism of Say s Law in a Money Economy According to classical economists and Say s law, if consumption spending falls because saving increases, the added saving will put downward pressure on the interest rate, and at a lower interest rate businesses will borrow and invest more. As a result, total spending will not fall. Keynes disagreed. He didn t think that added saving would necessarily stimulate an equal amount of added investment spending. According to Keynesian view, the fall in interest rate would increase investment but not by enough to prevent a decline in aggregate spending. And if, at a given price level, total spending falls, so will aggregate demand. In other words, according to Keynes, aggregate demand could fall if saving increases.

6 Keynes s Criticism of Say s Law in a Money Economy

7 Keynes s Criticism of Say s Law in a Money Economy The classical economists believed that saving and investment depend on the interest rate. Keynes believed that both saving and investment depend on a number of factors that may be far more influential than the interest rate. Saving is more responsive to changes in income than to changes in the interest rate. Investment is more responsive to technological changes, business expectations, and innovations than to changes in the interest rate.

8 Keynes s Criticism of Say s Law in a Money Economy Consider the difference between Keynes and the classical economists on saving. The classical economists held that saving is directly related to the interest rate: As the interest rate goes up, saving rises; as the interest rate goes down, saving falls, ceteris paribus. Keynes thought this assumption might not always be true. Suppose individuals are saving for a certain goal say, a retirement fund of $100,000. They might save less per period at an interest rate of 10 percent than at an interest rate of 5 percent because a higher interest rate means that they can save less per period and still meet their goal by retirement.

9 Keynes s Criticism of Say s Law in a Money Economy As for investment, Keynes believed that the interest rate is important in determining the level of investment, but not as important as other variables, such as the expected rate of profit on investment. Keynes argued that if business expectations are pessimistic, then much investment is unlikely, regardless of how low the interest rate is.

10 Keynes on Wage Rates As explained in the last chapter, if the unemployment rate in the economy is greater than the natural unemployment rate, a surplus exists in the labor market. Consequently, according to classical economists, wage rates will fall. According to Keynesian economists, wage rates may be inflexible in a downward direction. Employees will naturally resist an employer s efforts to cut wages. Labor unions may resist wage cuts.

11 Keynes on Wage Rates The Labor Market and Inflexible Wages Downward We start with D 1 and S 1 and the labor market in equilibrium at point 1. The equilibrium wage rate is W 1. The demand for labor declines, and the new equilibrium wage rate is W 2. Will employers end up paying W 2?

12 Keynes on Wage Rates The Labor Market and Inflexible Wages Downward Not necessarily, say economists who believe the wage rate is inflexible downward. The reasons they offer include longterm labor contracts, fear of declining productivity resulting from lower wages, and avoiding having disgruntled workers in the workplace (efficiency wage theory).

13 Keynes on Wage Rates If Keynes is correct and wage rates will not fall, is the economy then unable to get itself out of a recessionary gap? The unequivocal answer is yes. If employee and labor union resistance prevents wage rates from falling, then the SRAS curve will not shift to the right. If it does not shift to the right, the price level won t come down. If the price level does not come down, buyers will not purchase more goods and services and move the economy out of a recessionary gap. Keynes believed that the economy is inherently unstable and that it may not automatically cure itself of a recessionary gap. It may not be self-regulating.

14 Keynes on Wage Rates

15 Different Markets, Different Rates of Adjustment Take for example the Stock market: stock prices are flexible (upward and downward), and they move quickly to their equilibrium value. For example, the demand for stock A might rise at 10 o clock in the morning, and one minute later, at 10:01, the new higher equilibrium price of stock A is reached. Now not all markets adjust to their equilibrium values as quickly as the stock market. Many economists argue that the labor market might be very different from the stock market. Many economists argue that, in the labor market, wages may adjust very slowly to their new equilibrium values. For some period of time, wages may not adjust at all, especially when there is a surplus of labor and we would expect wages to decline.

16 Is It a Question of the Time It Takes for Wages and Prices to Adjust? Suppose the economy is in a recessionary gap at point 1. Wage rates are $10 per hour, and the price level is P 1. The issue may not be whether wage rates and the price level fall, but how long they take to reach longrun levels. If they take a short time (e.g., few weeks to a month), then classical economists are right: The economy is self-regulating. If they take a long time perhaps years then Keynes is right: The economy is not self-regulating over any reasonable period of time.

17 Keynes on Prices Again, recall what classical economists believe occurs when a recessionary gap exists: Wage rates fall, the SRAS curve shifts to the right, and the price level begins to decrease stop right there! The phrase the price level begins to decrease tells us that classical economists believe that prices in the economy are flexible: They move up and down in response to market forces. Keynes said that the internal structure of an economy is not always competitive enough to allow prices to fall. Anticompetitive or monopolistic elements in the economy sometimes prevent price from falling.

18 The Financial and Economic Crisis of Can a Housing Bust Lead to an Imploding Economy? Suppose an economy in long-run equilibrium undergoes a shock, such as the bursting of the housing bubble, with the prices of houses dropping. In the United States, housing prices started declining in mid Because the value of a house is a part of a person s overall wealth, a decline in it leads to a decline in a person s wealth. As a result of a decline in wealth, the person is poorer (or less rich) and consequently cuts back on consumption. A decline in consumption leads to a decline in aggregate demand, and so the aggregate demand curve shifts leftward, and the economy is in a recessionary gap.

19 The Financial and Economic Crisis of Can a Housing Bust Lead to an Imploding Economy? If the economy were self-regulating, it could get itself out of the recessionary gap. But if wages are inflexible downward, the economy is stuck in the recessionary gap.

20 The Financial and Economic Crisis of Can a Housing Bust Lead to an Imploding Economy? The labor market is initially in equilibrium at point 1. As a result of aggregate demand falling, firms are selling less output [panel (a)]. So they do not need as much labor, and the demand for labor shifts leftward [panel (b)]. Because the wage rate is inflexible downward, the number of workers hired in the labor market falls from 10 million to 8 million. Two million workers are fired.

21 The Financial and Economic Crisis of Can a Housing Bust Lead to an Imploding Economy? As workers are fired, their incomes fall; as a result of lower incomes, individuals cut back on consumption. So aggregate demand shifts leftward again and into a deeper recessionary gap. Graphically, in panel (c), instead of being between Q 1 and Q 2, the recessionary gap is between Q 1 and Q 3.

22 Summary: Differences between Classical and Keyensian Views

23 The Keynesian Model Assumptions First, the price level is assumed to be constant until the economy reaches its full employment or Natural Real GDP level. Second, there is no foreign sector: the model represents a closed economy, not an open economy. So total spending in the economy is the sum of consumption, investment, and government purchases. (This is an assumption of the Simple Keynesian Model. For some of our analysis, we will relax this assumption) Third, the monetary side of the economy is excluded. Since price level is fixed, Aggregate demand determines equilibrium real GDP. What determines aggregate expenditure plans?

24 Fixed Prices and Expenditure Plans Expenditure Plans The components of aggregate expenditure sum to real GDP. That is, Y = C + I + G + X M. Two of the components of aggregate expenditure, consumption and imports, are influenced by real GDP. So there is a two-way link between aggregate expenditure and real GDP.

25 Fixed Prices and Expenditure Plans Two-Way Link Between Aggregate Expenditure and Real GDP Other things remaining the same, An increase in real GDP increases aggregate expenditure. An increase in aggregate expenditure increases real GDP.

26 Fixed Prices and Expenditure Plans Consumption and Saving Plans Consumption expenditure is influenced by many factors but the most direct one is disposable income. Disposable income is aggregate income or real GDP, Y, minus net taxes, T. Call disposable income YD. The equation for disposable income is YD = Y T

27 Fixed Prices and Expenditure Plans Disposable income, YD, is either spent on consumption goods and services, C, or saved, S. That is, YD = C + S. The relationship between consumption expenditure and disposable income, other things remaining the same, is the consumption function. The relationship between saving and disposable income, other things remaining the same, is the saving function. Figure in the next slide illustrates the consumption function and the saving function.

28 When consumption expenditure exceeds disposable income, saving is negative (dissaving). When consumption expenditure is less than disposable income, there is saving.

29 Fixed Prices and Expenditure Plans Marginal Propensities to Consume and Save The marginal propensity to consume (MPC) is the fraction of a change in disposable income spent on consumption. It is calculated as the change in consumption expenditure, C, divided by the change in disposable income, YD, that brought it about. That is, MPC = C YD

30 Fixed Prices and Expenditure Plans The Figure below shows that the MPC is the slope of the consumption function. When disposable income increases by $2 trillion, consumption expenditure increases by $1.5 trillion. The MPC is 0.75.

31 Fixed Prices and Expenditure Plans The marginal propensity to save (MPS) is the fraction of a change in disposable income that is saved. It is calculated as the change in saving, S, divided by the change in disposable income, YD, that brought it about. That is, MPS = S YD

32 Fixed Prices and Expenditure Plans The following Figure shows that the MPS is the slope of the saving function. When disposable income increases by $2 trillion, saving increases by $0.5 trillion. The MPS is 0.25.

33 Fixed Prices and Expenditure Plans The MPC plus the MPS equals 1. To see why, note that, C + S = YD. Divide this equation by YD to obtain, C/ YD + S/ YD = YD/ YD or MPC + MPS = 1.

34 Fixed Prices and Expenditure Plans Consumption as a Function of Real GDP Disposable income changes when either real GDP changes or net taxes change. If tax rates don t change, real GDP is the only influence on disposable income, so consumption expenditure is a function of real GDP. We use this relationship to determine real GDP when the price level is fixed. C = C 0 + b(yd) = C 0 + b Y T = C 0 + b Y ty = C 0 + b 1 t Y Here, C 0 denotes autonomous consumption, bdenotes MPC and tdenotes tax rate.

35 Fixed Prices and Expenditure Plans Import Function In the short run, imports are influenced primarily by real GDP. The marginal propensity to import (m) is the fraction of an increase in real GDP spent on imports. If an increase in real GDP of $1 trillion increases imports by $0.25 trillion, the marginal propensity to import is M = my

36 Real GDP with a Fixed Price Level When the price level is fixed, aggregate demand is determined by aggregate expenditure plans. Aggregate planned expenditure is planned consumption expenditure plus planned investment plus planned government expenditure plus planned exports minus planned imports.

37 Real GDP with a Fixed Price Level Planned consumption expenditure and planned imports are influenced by real GDP. When real GDP increases, planned consumption expenditure and planned imports increase. Planned investment plus planned government expenditure plus planned exports are not influenced by real GDP.

38 Real GDP with a Fixed Price Level Aggregate Planned Expenditure The relationship between aggregate planned expenditure and real GDP can be described by an aggregate expenditure schedule, which lists the level of aggregate expenditure planned at each level of real GDP. The relationship can also be described by an aggregate expenditure curve, which is a graph of the aggregate expenditure schedule.

39 Real GDP with a Fixed Price Level This Figure shows how the aggregate expenditure curve (AE) is built from its components.

40 Real GDP with a Fixed Price Level Consumption expenditure minus imports, which varies with real GDP, is induced expenditure. The sum of investment, government expenditure, and exports, which does not vary with GDP, is autonomous expenditure. Consumption as explained before also has an autonomous component.

41 Real GDP with a Fixed Price Level Actual Expenditure, Planned Expenditure, and Real GDP Actual aggregate expenditure is always equal to real GDP. Aggregate planned expenditure may differ from actual aggregate expenditure because firms can have unplanned changes in inventories. People carry out their consumption expenditure plans, the government implements its planned expenditure on goods and services, and net exports are as planned. Firms carry out their plans to purchase new buildings, plant and equipment.

42 Real GDP with a Fixed Price Level Businesses produce the goods and services that are bought by household, business, government and the rest of the world (ROW). Sometimes, though, businesses produce too much or too little in comparison to what these sectors buy. For example, Assume that business firms hold an optimum inventory level of $300 billion worth of goods and they produce $11 trillion worth of goods and services (GDP = $11 trillion), but the four sectors buy only $10.8 trillion worth (Planned expenditure = $10.8 trillion). In this case, businesses have produced too much relative to what the four sectors buy and inventory levels rise unexpectedly to $500 billion, which is $200 billion more than the $300 billion that firms see as optimal. This unexpected rise in inventories signals to firms that they have overproduced. Consequently, they cut back on the quantity of goods they are producing. The cutback in production causes Real GDP to fall, bringing Real GDP closer to the (lower) output level that the three sectors of the economy and the ROW are willing and able to buy. Ultimately, GDP will equal Aggregate Planned Expenditure.

43 Real GDP with a Fixed Price Level Assume that business firms hold their optimum inventory level ($300 billion worth of goods), that they produce $10.4 trillion worth of goods (GDP = $10.4 trillion), and that the four sectors buy $10.6 trillion worth of goods (Planned expenditure = $10.6 trillion). How can individuals buy more than businesses produce? Firms make up the difference out of inventory. In our example, inventory levels fall from $300 billion to $100 billion because individuals purchase $200 billion more of goods than firms produced (to be sold). This is why firms maintain inventories in the first place: to be able to meet an unexpected increase in sales. The unexpected fall in inventories signals to firms that they have underproduced. Consequently, they increase the quantity of goods they produce. The rise in production causes Real GDP to rise, in the process bringing Real GDP closer to the (higher) real output that the four sectors are willing and able to buy. Ultimately, GDP will equal Aggregate Planned Expenditure.

44 Real GDP with a Fixed Price Level Equilibrium Expenditure Equilibrium expenditure is the level of aggregate expenditure that occurs when aggregate planned expenditure equals real GDP. This Figure illustrates equilibrium expenditure. Equilibrium occurs at the point at which the AE curve crosses the 45 line in part (a). Equilibrium occurs when there are no unplanned changes in business inventories in part (b).

45 Real GDP with a Fixed Price Level Convergence to Equilibrium From Below Equilibrium If aggregate planned expenditure exceeds real GDP, there is an unplanned decrease in inventories. To restore inventories, firms hire workers and increase production. Real GDP increases.

46 Real GDP with a Fixed Price Level From Above Equilibrium If real GDP exceeds aggregate planned expenditure, there is an unplanned increase in inventories. To reduce inventories, firms fire workers and decrease production. Real GDP decreases.

47 Real GDP with a Fixed Price Level If aggregate planned expenditure equals real GDP (the AE curve intersects the 45 line), there is no unplanned change in inventories. And firms maintain their current production. Real GDP remains constant.

48 The Multiplier When autonomous expenditure changes, so does equilibrium expenditure and real GDP. But the change in equilibrium expenditure is larger than the change in autonomous expenditure. The multiplier is the amount by which a change in autonomous expenditure is magnified or multiplied to determine the change in equilibrium expenditure and real GDP.

49 The Multiplier The Basic Idea of the Multiplier An increase in investment (or any other component of autonomous expenditure) increases aggregate expenditure and real GDP. The increase in real GDP leads to an increase in induced expenditure. The increase in induced expenditure leads to a further increase in aggregate expenditure and real GDP. So real GDP increases by more than the initial increase in autonomous expenditure.

50 The Multiplier This Figure illustrates the multiplier. An increase in autonomous expenditure brings an unplanned decrease in inventories. So firms increase production and real GDP increases to a new equilibrium.

51 The Multiplier Why Is the Multiplier Greater than 1? The multiplier is greater than 1 because an increase in autonomous expenditure induces further increases in aggregate expenditure. The Size of the Multiplier The size of the multiplier is the change in equilibrium expenditure divided by the change in autonomous expenditure.

52 The Multiplier The Multiplier and the Slope of the AE Curve If the change in real GDP is Y, the change in autonomous expenditure is A, then Multiplier= Y A The slope of the AE curve determines the magnitude of the multiplier: Multiplier = 1 1 Slope of AE curve = 1 1 e

53 The Multiplier What is the Slope of the AE Curve? Start from: AE = C + I + G + X M Perform necessary algebraic manipulation to get to: AE = C 0 + I + G + X + b 1 t m Y AE = A + ey Where A denotes autonomous expenditure and e denotes the slope of the AE curve.

54 The Multiplier Deriving the Multiplier Formula We can mathematically define Multiplier as: Multiplier= Y A The Multiplier formula is: Y A = 1 1 b 1 t m = 1 1 e Start with: Y = C + I + G + X M Perform necessary algebraic manipulation to get to: Y = 1 1 e C 0 + I + G + X = 1 1 e A Y A = 1 1 e

55 The Multiplier With the numbers in the previous Figure, the slope of the AE curve is 0.75, so the multiplier is Y / A = 1 / (1-0.75) = 1 / 0.25 = 4. When there are no income taxes and no imports, the slope of the AE curve equals the marginal propensity to consume, so the multiplier is Multiplier = 1 / (1 - MPC). But 1 MPC = MPS, so the multiplier is also Multiplier = 1 / MPS.

56 The Multiplier Imports and Income Taxes Both imports and income taxes reduce the size of the multiplier. This Figure shows how. In part (a) with no taxes or imports, the slope of the AE curve is 0.75 and the multiplier is 4.

57 The Multiplier In part (b), with taxes and imports, the slope of the AE curve is 0.5 and the multiplier is 2.

58 The Multiplier The Multiplier Process This Figure illustrates the multiplier process. The MPC determines the magnitude of the amount of induced expenditure at each round as aggregate expenditure moves toward equilibrium expenditure.

59 The Multiplier and Reality So, in simple terms, a change in autonomous spending leads to a greater change in total spending. Also, in the Keynesian model, the change in total spending is equal to the change in Real GDP (assuming that the economy is operating below Natural Real GDP). The reason is that, in the model, prices are assumed to be constant until Natural GDP is reached; so any change in nominal total spending is equal to the change in real total spending. However, two reality checks are necessary.

60 The Multiplier and Reality First, the multiplier takes time to have an effect. In a textbook, going from an initial increase in autonomous spending to a multiple increase in either total spending or Real GDP takes only seconds. In the real world, this process takes many months. Second, for the multiplier to increase Real GDP, idle resources must exist at each spending round. After all, if Real GDP is increasing (output is increasing) at each spending round, idle resources must be available to be brought into production. If they are not available, then increased spending will simply result in higher prices without an increase in Real GDP. Simply put, GDP will increase, but not Real GDP.

61 The Simple Keynesian Model in the AD AS Framework Shifts in the Aggregate Demand Curve Now, we will assume a closed economy (no export or import) to be consistent with the Text. Because there is no foreign sector in the simple Keynesian model, total spending consists of consumption (C), investment (I), and government purchases (G). Because the economy has no monetary side, changes in any of these variables (C, I, G) can shift the AD curve. For example, a rise in consumption will shift the AD curve to the right; a decrease in investment will shift it to the left.

62 The Simple Keynesian Model in the AD AS Framework Shifts in the Aggregate Demand Curve This Figure illustrates the effects of an increase in investment. The AE curve shifts upward and the AD curve shifts rightward by an amount equal to the change in investment multiplied by the multiplier.

63 The Simple Keynesian Model in the AD AS Framework Shifts in the Aggregate Demand Curve Let s consider the effect of an increase in autonomous consumption on aggregate demand. A rise in autonomous consumption (C 0 ) will raise consumption (C) and therefore shift the AD curve to the right. How much the AD curve will shift depends on the multiplier. Let s say, C 0 increases by $40, and the multiplier is 5. Y = Multiplier C 0 = 5 $40 = $200

64 The Simple Keynesian Model in the AD AS Framework The Multiplier and Aggregate Demand An initial increase in autonomous consumption raises total spending and shifts the aggregate demand curve from AD 1 to AD 2. The AD curve does not end here, however. Because of the multiplier, the increase in autonomous spending generates additional income and additional spending, shifting the aggregate demand curve to AD 3. Part of this shift ($40) is due to the initial rise in autonomous consumption, and part ($160) is due to the multiplier.

65 The Simple Keynesian Model in the AD AS Framework The Keynesian Aggregate Supply Curve As noted, in the simple Keynesian model, the price level is assumed to be constant until it reaches its full-employment or Natural Real GDP level. What does this assumption say about the Keynesian aggregate supply curve? Think back to the discussions of aggregate demand and aggregate supply. The AD curve is downward sloping, and the SRAS curve is upward sloping. Therefore, any shift in the AD curve (rightward or leftward) will automatically change (raise or lower) the price level. If the price level is assumed to be constant, then the Keynesian aggregate supply curve must have a horizontal section.

66 The Simple Keynesian Model in the AD AS Framework The AS Curve in the Simple Keynesian Model The AS curve in the simple Keynesian model is horizontal until Q N (Natural Real GDP) and vertical at Q N. It follows that any changes in aggregate demand in the horizontal section do not change the price level, but any changes in aggregate demand in the vertical section do change the price level.

67 The Simple Keynesian Model in the AD AS Framework The AS Curve in the Simple Keynesian Model In our example, a rise in autonomous consumption of $40 generated an additional $160 worth of spending so that total spending increased by $200. Under what condition will a $200 increase in total spending lead to a $200 increase in Real GDP? That happens when the aggregate supply curve is horizontal, i.e., when Q < Q N.

68 The Simple Keynesian Model in the AD AS Framework The AS Curve in the Simple Keynesian Model In other words, the AD curve in the economy must be shifting rightward (due to the increased spending) but must be within the horizontal section of the Keynesian AS curve.

69 The Simple Keynesian Model in the AD AS Framework The Economy in a Recessionary Gap The economy is at point A producing Q 1. Q 1 < Q N, so the economy is in a recessionary gap. The question is whether the private sector (consisting of consumption and investment spending) can remove the economy from the recessionary gap by increasing spending enough to shift the aggregate demand curve rightward to go through point B.

70 The Simple Keynesian Model in the AD AS Framework The Economy in a Recessionary Gap Keynes believed that sometimes it could not. No matter how low interest rates fell, investment spending would not rise because of pessimistic business expectations with respect to future sales.

71 The Simple Keynesian Model in the AD AS Framework Government s Role in the Economy In the self-regulating economy of the classical economists, government does not have a management role to play. The private sector (households and businesses) is capable of selfregulating the economy at its Natural Real GDP level. On the other hand, Keynes believed that the economy is not self-regulating and that economic instability is a possibility. In other words, the economy could get stuck in a recessionary gap.

72 The Simple Keynesian Model in the AD AS Framework Government s Role in the Economy Economic instability opens the door to government s playing a role in the economy. According to Keynes and to many Keynesians, if the private sector cannot selfregulate the economy at its Natural Real GDP level, then maybe the government must help. In terms of this Figure, maybe the government has a role to play in shifting the AD curve rightward so that it goes through point B.

73 The Simple Keynesian Model in the AD AS Framework Government s Role in the Economy Economic instability opens the door to government s playing a role in the economy. According to Keynes and to many Keynesians, if the private sector cannot selfregulate the economy at its Natural Real GDP level, then maybe the government must help. In terms of this Figure, maybe the government has a role to play in shifting the AD curve rightward so that it goes through point B.

74 The Theme of the Simple Keynesian Model In terms of AD and AS, the essence of the simple Keynesian model can be summarized in five statements: 1. The price level is constant until Natural Real GDP is reached. 2. The AD curve shifts if there are changes in C, I, or G. 3. According to Keynes, the economy could be stuck in a recessionary gap. 4. The private sector may not be able to get the economy out of a recessionary gap. 5. The government may have a management role to play in the economy. According to Keynes, government may have to raise aggregate demand enough to stimulate the economy to move it out of the recessionary gap and to its Natural Real GDP level.

75 The Multiplier and the Price Level Equilibrium Real GDP and the Price Level What if the SRAS is in fact upward sloping as suggested by the Classical Economists? This Figure shows the effect of an increase in investment in the short run when the price level changes.

76 The Multiplier and the Price Level The increase in investment shifts the AE curve upward and shifts the AD curve rightward. With no change in the price level, real GDP would increase to $15 trillion at point B.

77 The Multiplier and the Price Level But the price level rises. The AE curve shifts downward. Equilibrium expenditure decreases to $14.3 trillion As the price level rises, real GDP increases along the SAS curve to $14.3 trillion. The multiplier in the short run is smaller than when the price level is fixed.

78 The Multiplier and the Price Level This Figure illustrates the long-run effects. At point C in part (b), there is an inflationary gap. The money wage rate starts to rise and the SAS curve starts to shift leftward.

79 The Multiplier and the Price Level The money wage rate will continue to rise and the SAS curve will continue to shift leftward,... until real GDP equals potential GDP. In the long run, the multiplier is zero.