Aggregate Demand and Aggregate Supply

Transcription

1 Aggregate Demand and Aggregate Supply SLIDES PREPARED BY JUDITH SKUCE, GEORGIAN COLLEGE 1

2 In this chapter you will learn 8.1 What determines the shape of the aggregate demand curve and what factors shift the entire curve 8.2 What determines the shape of the aggregate supply curve, and what factors shift the entire curve 8.3 How the equilibrium price level and real GDP are determined 8.4 How the economy arrives at its long run equilibrium 8.5 Equilibrium vs. full-employment GDP 2

3 Chapter 8 Topics 8.1 Aggregate Demand 8.2 Aggregate Supply 8.3 Equilibrium GDP & Changes in Equilibrium 8.4 From the Short Run to the Long Run 8.5 Equilibrium Versus Full-Employment GDP 3

4 Aggregate Demand (AD) The amounts of real output that buyers collectively desire to purchase at each possible price level 4

5 Price Level Aggregate Demand (AD) Aggregate Quantity Demanded (Real GDP) and the Price Level are inversely related as follows: Figure 8-1 AD Real GDP 5

6 Aggregate Demand (AD) slopes downward because of the following effects of a change in price level: 1. Real-balances Effect 2. Interest-rate Effect 3. Foreign Trade Effect Remember: these effects are caused by price level changes 6

7 Price level Changes in Aggregate Demand Figure 8-2 AD Can Increase Real domestic output, GDP AD 1 7

8 Price level Changes in Aggregate Demand Figure 8-2 AD Can Increase shift RIGHT AD 1 AD 2 Real domestic output, GDP 8

9 Price level Changes in Aggregate Demand Figure 8-2 AD Can Decrease Real domestic output, GDP AD 1 9

10 Price level Changes in Aggregate Demand Figure 8-2 AD Can Decrease shift LEFT AD 3 Real domestic output, GDP AD 1 10

11 Determinants of Aggregate Demand Consumer Spending Consumer wealth Consumer expectations Taxes Household indebtedness 11

12 Determinants of Aggregate Demand Investment Spending Real Interest Rates Expected Returns Expectations about future business conditions Technology Degree of excess capacity Business taxes 12

13 Determinants of Aggregate Demand Government Spending Net Export Spending National Income Abroad Exchange Rates 13

14 Chapter 8 Topics 8.1 Aggregate Demand 8.2 Aggregate Supply 8.3 Equilibrium GDP & Changes in Equilibrium 8.4 From the Short Run to the Long Run 8.5 Equilibrium Versus Full-Employment GDP 14

15 Aggregate Supply The level of real domestic output that will be produced at each price level Production responses to price level changes differ in the long run & the short run 15

16 Price level Aggregate Supply in the Long Run in the long run, the aggregate supply curve is vertical at the economy s fullemployment output (potential GDP) AS LR GDP f Real domestic output, GDP 16

17 Aggregate Supply in the Long Run in the long run, wages & other input prices rise or fall to match changes in the price level changes in the price level do not change real profit & there is no change in real output 17

18 Price level Aggregate Supply in the Short Run in reality, nominal wages adjust only slowly to changes in the price level short-run aggregate supply curve is upwardsloping AS GDP f Real domestic output, GDP 18

19 Aggregate Supply in the Short Run as the economy expands in the short run, perunit production costs generally rise the extent of the rise depends on where the economy is unless operating, stated relative otherwise, to its capacity an economy aggregate operating below supply its full-employment output has idle capital & labour little upward pressure on refers production to AS costs in the short run when the economy is operating beyond its fullemployment output, most available resources are already employed per-unit production costs increase as economy expands 19

20 Determinants of Aggregate Supply 1. Change in input prices a. Domestic resource price b. Price of imported resources c. Market power 2. Change in productivity 3. Change in legal-institutional environment a. Business taxes & subsidies b. Government regulation 20

21 Chapter 8 Topics 8.1 Aggregate Demand 8.2 Aggregate Supply 8.3 Equilibrium GDP & Changes in Equilibrium 8.4 From the Short Run to the Long Run 8.5 Equilibrium Versus Full-Employment GDP 21

22 Equilibrium GDP Equilibrium occurs at the price level that equalizes the amount of real output demanded & supplied A price level too low would mean AD>AS, putting upward pressure on prices across the economy 22

23 Price Level AD Price Level Too Low Figure 8-6 AS upward pressure PL 1 AS 1 AD 1 Real GDP 23

24 Equilibrium GDP similarly, a price level too high would mean AD<AS, putting downward pressure on prices across the economy 24

25 Price Level AD Price Level Too High Figure 8-6 AS PL 2 downwar d pressure AD 2 AS 2 Real GDP 25

26 Changes in Equilibrium Are caused by changes (shifts) in AD and/or AS 26

27 Increases in AD for any initial increase in aggregate demand, the resulting increase in real output will be smaller the greater is the increase in the price level demand-pull inflation 27

28 Price level Increases in AD Figure 8-7 P 2 P 1 AS output does not increase all the way to GDP 1 because of inflation AD 2 GDP f GDP 2 AD 1 Real GDP GDP 1 28

29 Decreases in AD Deflation is a rarity in the Canadian economy Real output takes the full brunt of the decline in AD because product prices are sticky in the short run wage contracts morale, effort, & productivity minimum wage menu costs fear of price wars 29

30 Price level Decreases in AD Figure 8-8 prices are sticky downwards AS P 1 GDP 1 GDP f AD 2 AD 1 Real GDP 30

31 Decreases in AS: Cost-Push Inflation effects of a leftward shift in AS are doubly bad output decreases price level increases 31

32 Price level Decreases in AS Figure 8-9 AS 2 AS 1 P 2 P 1 GDP 2 GDP f AD 1 Real GDP 32

33 Increases in AS increases in AD should normally lead to inflation recently, productivity growth has shifted the long-run AS curve to the right 33

34 Price level Increases in AS Figure 8-10 AS 1 AS 2 P 3 P 2 P 1 GDP 1 GDP 2 GDP 3 AD 1 AD 2 Real GDP 34

35 Chapter 8 Topics 8.1 Aggregate Demand 8.2 Aggregate Supply 8.3 Equilibrium GDP & Changes in Equilibrium 8.4 From the Short Run to the Long Run 8.5 Equilibrium Versus Full-Employment GDP 35

36 From the Short Run to the Long Run nominal wages & other input prices may remain constant in the short run, even though the price level has changed once contracts have expired & nominal wage adjustments have been made, the economy enters the long run 36

37 Price level Short-Run Aggregate Supply Figure 8-11 P 2 P 1 a 1 a 2 AS 1 an increase in price level increases profits & output, moving the economy from a 1 to a 2 GDP f GDP 2 Real domestic output 37

38 Price level Short-Run Aggregate Supply Figure 8-11 P 1 P 3 a 3 a 1 AS 1 a decrease in price level decreases profits & output, moving the economy from a 1 to a 3 GDP 3 GDP f Real domestic output 38

39 Price level Long-Run Aggregate Supply P 2 P 1 Figure 8-11 AS LR b 1 a 1 AS 2 AS 1 GDP f GDP 2 Real domestic output 39 a 2 an increase in price level leads to increases in nominal wages, shifting shortrun AS leftward new equilibrium at b 1

40 Price level Long-Run Aggregate Supply P 1 P 3 Figure 8-11 a 1 AS LR a 3 c 1 AS 1 AS 3 a decrease in price level leads to decreases in nominal wages, shifting shortrun AS rightward new equilibrium at c 1 GDP 3 GDP f GDP 2 Real domestic output 40

41 Price level Equilibrium in the Long-Run AD-AS Model Figure 8-12 AS LR AS 1 P 1 a AD 1 GDP f 41

42 Chapter 8 Topics 8.1 Aggregate Demand 8.2 Aggregate Supply 8.3 Equilibrium GDP & Changes in Equilibrium 8.4 From the Short Run to the Long Run 8.5 Equilibrium Versus Full-Employment GDP 42

43 Equilibrium Versus Full-Employment GDP There is no guarantee, in the short run, that equilibrium GDP will be fullemployment GDP 43

44 Recessionary Gap A recessionary gap occurs when AD is too low, and equilibrium GDP is below potential GDP 44

45 Price level Recessionary Gap Figure 8-13 AS LR Potential GDP AS Recessionary Gap = 20 P 0 P 1 AD 0 AD Real GDP 45

46 Inflationary Gap An inflationary gap occurs when AD is too high, and equilibrium GDP is above potential GDP 46

47 Price level Inflationary Gap Figure 8-13 AS LR Potential GDP AS Inflationary Gap = 20 P 1 AD 2 P 0 AD Real GDP 47

48 Chapter 8 Topics 8.1 Aggregate Demand 8.2 Aggregate Supply 8.3 Equilibrium GDP & Changes in Equilibrium 8.4 From the Short Run to the Long Run 8.5 Equilibrium Versus Full-Employment GDP 48

49 Chapter 8 Appendix The Relationship of the Aggregate Expenditures Model to the AD-AS Model 49

50 Derivation of AD Curve AD can be derived from the Aggregate Expenditures Model illustrated 50

51 Price level Aggregate expenditures (billions of dollars) Figure A8-1 1 AE 1 at P 1 0 GDP 1 What if prices go up? Real GDP P 1 0 GDP 1 1' Real GDP Real GDP at price level 1

52 Price level Aggregate expenditures (billions of dollars) Figure A AE 1 at P 1 AE 2 at P 2 0 GDP 2 GDP 1 What if prices go up Real GDP again? P 2 P 1 0 2' 1' GDP 2 GDP 1 Real GDP A Lower Real GDP at price level 2

53 Price level Aggregate expenditures (billions of dollars) Figure A AE 1 at P 1 AE 2 at P 2 AE 3 at P GDP 3 GDP 2 GDP 1 Real GDP P 3 3' P 2 P 1 0 2' 1' GDP 3 GDP 2 GDP 1 Real GDP A Still Lower Real GDP Level at price level 3

54 Price level Aggregate expenditures (billions of dollars) Figure A AE 1 at P 1 AE 2 at P 2 AE 3 at P 3 0 Real GDP GDP 3 GDP 2 GDP 1 P 3 3' P 2 2' Aggregate Demand can be derived from AE P 1 1' 0 GDP 3 GDP 2 GDP 1 Real GDP

55 Shifts in AD and shifts in Aggregate Expenditure illustrated 55

56 Price level Aggregate expenditures (billions of dollars) Figure A8-2 AE 2 at P 1 AE 1 at P 1 An Increase in Aggregate Expenditures 0 GDP 1 GDP 2 Real GDP P 1 An Increase in Aggregate Demand AD 2 0 GDP 1 GDP 2 AD 1 Real GDP