Aggregate Demand & Aggregate Supply

Transcription

1 Aggregate Demand & Aggregate Supply 1

2 Aggregate Demand AD = C + I + G + NX The sum of planned consumption, investment, government, and net exports expenditures on final goods and services 2

3 Aggregate Demand Curve Shows amounts of real output (real GDP) that buyers collectively desire to purchase at each possible price level Price Level and output demanded are inversely related 3

4 Downward Slope of AD Real-balances Effect (Wealth Effect) A higher price level reduces the purchasing power savings balances The public is more poor in real terms and will reduce spending A lower price level makes you seem wealthier while a higher price level makes you seem less wealthy Interest-rate effect A higher price level will increase money demand and drive up the price paid for its use (interest rate) If the price level rises, consumers and businesses need more money to consume or invest, increasing demand for money Foreign Purchases Effect (Net Export Effect) When prices rise relative to foreign prices, Exports fall and Imports rise foreigners buy fewer U.S. goods Americans buy more foreign goods 4

5 Consumer Spending (C) (Largest) Consumer Wealth Real Interest Rates Expectations (income & prices) Taxes Increase in C leads to an increase in AD Shift to the right 5

6 Investment spending (I) (unstable) Interest Rates Expected Returns (Shifts of Investment Demand) Expected future business condition Technology Stock of capital goods on hand Business taxes Acquisition, maintenance, and operating costs Increase in I leads to an increase in AD Shift to the right 6

7 Government spending (G) When the government spends more, the AD curve shifts to the right, as long as the interest rates and tax collections do not change Increase in G leads to an increase AD Shift to the right 7

8 Net export spending (NX) National income abroad Rising national income abroad encourages foreigners to buy more products Net exports of the U.S. rise Exchange rates If the U.S. dollar depreciates in terms of the euro, the new higher value euros enable consumers to obtain more dollars with each euro exports rise, imports fall leading to an increase NX Increase in NX leads to an increase in AD Shift to the right 8

9 Aggregate Supply Curve Aggregate Supply The total supply of all goods and services in the economy AS Curve Price level and output supplied are directly related 9

10 SRAS Short Run Capital and level of technology are fixed Only the quantity of labor changes Short-run Aggregate Supply Curve (SRAS) Assumes that nominal wages and resource prices do not respond to changes in price level 10

11 Determinants of Aggregate Supply Resource Prices Wages SRAS (curve shifts left) Price of machinery cost SRAS Land resources cost SRAS Higher productivity = lower costs = increase AS Business taxes = costs = SRAS Subsidy = costs = SRAS Regulation, costs, SRAS 11

12 Long Run Aggregate Supply (LRAS) Vertical at the economy s full employment output In the long run, nominal wages (& other input prices) rise or fall to match changes in the PL Changes in PL therefore do not change real profit, and there is no change in real output From short run to long run If AD increases, PL & Y will increase in the SR, but In the LR, nominal wages will increase and SRAS will decrease and The economy will return to full employment output 12

13 Economic Growth Increase LRAS Increase in the quantity of capital Technological Advance Increase in the quantity & quality of natural and human resources 13

14 Fiscal Policy Controlled by the US Government (Congress and the President) 2 Primary Tools Government Spending Taxes 14

15 Fiscal Policy Changes in Government Spending affect G Changes in Taxes affect C Is this supply-side or demand-side policy? Fiscal policy is only effective at correcting shifts of AD 15

16 Fiscal Policy Expansionary Response to recession/unemployment When output is to the left of Y* Increase G and/or Decrease T Increases AD Brings output back to Y* 16

17 Fiscal Policy Contractionary Policy Response to inflation When output is above Y* Decrease G and/or Increase T Decreases AD Brings output back to Y* 17

18 Fiscal Policy Automatic Stabilizers Adjust without action by Congress Examples: Income Tax System Unemployment Compensation 18

19 Crowding-out effect How will increased government borrowing affect: Loanable Funds Market? Investment and AD in the short-run? Long-run economic growth? An expansionary fiscal policy may increase the interest rate This could lead to a loss of funds for private investment due to government borrowing 19

20 Crowding Out Increase in the demand for loanable funds increases the interest rate and decreases investment 20

21 Problems of timing (Lag-time) Recognition Lag: The time between the beginning of recession or inflation and the awareness that it is actually occurring. This happens because of the difficulty in predicting the future course of economic activity Administrative Lag: The time between the recognition of the need for fiscal action and the time action is taken. This is the downside of democracy 9/11/01, the U.S. Congress was stalemated for two months before passing an economic stimulus law Operational Lag: Occurs between the time when fiscal action is taken and when the action takes effect on output, employment, or the price level. While tax rates can be implemented quickly, government public works require long planning periods and longer periods of construction 21