Aggregate Demand and Aggregate Supply

Transcription

1 29 Aggregate Demand and Aggregate Supply McGraw-Hill/Irwin Copyright 2012 by The McGraw-Hill Companies, Inc. All rights reserved.

2 AGENDA Mon 2/29 Team Teaching: CH 29 (cont) P3: Connor, Kaleb, Jorge, Zach P5: Ms. K On Deck: CH 35 (Tues) P3: Grant, Hannah, Jason, Pedro P5: Ms. K (again) HW: Read pp Q#1-2 LO1 29-2

3 QOD #18: 9-11 Effect In early 2001 investment spending sharply declined in the United States. In the 2 months following the September 11, 2001, attacks on the United States, consumption also declined. Use AD-AS analysis to show the two impacts on real GDP. LO1 29-3

4 QOD #18: 9-11 Effect Both events would be represented by a leftward shift in aggregate demand, and the initial declines in spending would be multiplied. This would cause a drop in real GDP and, assuming flexible prices, a drop in the price level. To the extent the decline in investment spending affected productivity, it could have either shifted AS left (if productivity dropped) or slowed the rightward movement of AS that occurred through much of the 1990s and into the early 2000s. LO1 29-4

5 Aggregate Demand Real GDP desired at each price level Inverse relationship Real balances effect-change in the price level. An increase in the price level reduces the real value of purchasing power which leads to less CONSUMPTION. Interest effect-if we assume the supply of money to be fixed, higher prices lead to a shortfall of dollars. Thus the demand for money rises, increasing the interest rate. This leads to less C and Ig. Foreign purchases effect-when the U.S. price level rises, foreigners will buy goods and Americans will buy foreign goods. LO1 29-5

6 Price level Aggregate Demand AD 0 Real domestic output, GDP LO1 29-6

7 Price level Changes in Aggregate Demand AD 2 LO1 0 AD 3 Real domestic output, GDP AD

8 Consumer Spending Consumer wealth-assets minus liabilities More wealth =. Household borrowing Consumer expectations if we expect our future incomes to rise we will spend more now. If we expect prices to rise in the future we may also spend now. Personal taxes LO1 29-8

9 Investment Spending Real interest rates-an increase raises borrowing costs. Expected returns Expectations about future business conditions If businesses think the economy will be better in the future they will forecast higher rates of return. Technology Degree of excess capacity-too much excess capacity gives businesses little incentive to INVEST more. Business taxes LO1 29-9

10 Government Spending Government spending increases Aggregate demand increases (as long as interest rates and tax rates do not change) More transportation projects Government spending decreases Aggregate demand decreases Less military spending, less unemployment LO

11 Net Export Spending National income abroad Exchange rates Dollar depreciation-??? Dollar appreciation-??? LO

12 Aggregate Supply Total real output produced at each price level Relationship depends on time horizon Immediate short run Short run-flat up to full emp. then rises quickly. WHY? Long run- Why is it vertical? LO

13 Price level AS: Immediate Short Run Immediate-short-run aggregate supply P 1 AS ISR 0 Q f Real domestic output, GDP LO

14 Price level Aggregate Supply: Short Run AS Aggregate supply (short run) 0 Q f Real domestic output, GDP LO

15 Price level Aggregate Supply: Long Run AS LR Long-run aggregate supply 0 Q f Real domestic output, GDP LO

16 Changes in Aggregate Supply Determinants of aggregate supply Shift factors Changes raise or lower per-unit production costs LO

17 Price level Changes in Aggregate Supply AS 3 AS 1 AS 2 0 Real domestic output, GDP LO

18 Input Prices Domestic resource prices Labor Capital Land Prices of imported resources Imported oil Exchange rates LO

19 Productivity Real output per unit of input Increases in productivity reduce costs Decreases in productivity increase costs Productivity = total output total inputs Per-unit production cost = total input cost total output LO

20 Legal-Institutional Environment Legal changes alter per-unit costs of output Taxes and subsidies Extent of government regulation More could lead to less agg. supply, however, if deregulation leads to unfair and unsafe business practices, it could move the other direction. Also, if agg. demand is strong enough, would businesses really cut back? LO

21 Price level (index numbers) Equilibrium AS Real Output Demanded (Billions) Price Level (Index Number) Real Output Supplied (Billions) $ $ a b AD Real domestic output, GDP (billions of dollars) LO

22 Price level Increases in AD: Demand-Pull Inflation AS P 2 P 1 AD 1 AD 2 0 Q f Q 1 Q 2 Real domestic output, GDP LO

23 Why? Firms boost investment spending because they anticipate higher future profits from investments in new capital. Government increases spending for such programs as national defense.

24 Price level Decreases in AD: Recession AS P 1 P 2 b c a AD 1 0 Q 1 Q 2 Q f AD 2 Real domestic output, GDP LO

25 Prices? Sticky prices Costs do not necessarily change-menu costs, minimum wage, wage contracts Morale, productivity-wage inflexibility Price wars

26 Price level Decreases in AS: Cost-Push Inflation AS 2 AS 1 P 2 P 1 b a AD 0 Q 1 Q f Real domestic output, GDP LO

27 Price level Increases in AS: Full-Employment AS 1 AS 2 P 3 P 2 P 1 a b c AD 2 AD 1 0 Q 1 Q 2 Q 3 Real domestic output, GDP LO