10 Demand and Supply 10-1 Chapter Objectives Demand and the Factors That Cause it to Change. Supply and the Factors That Cause it to Change. How AD and AS Determine an Economy s and the Level of Real GDP. How the AD-AS Model Explains Periods of Demand-Pull Inflation, Cost-Push Inflation, and Recession. 10-2 AD AS Model Demand- Supply Model (AD-AS Model). Demand. demand is a schedule or curve that shows the various amounts of real domestic output that domestic and foreign buyers will desire to purchase at each possible price level. Why the Downward Slope? Real-Balances Effect. Interest-Rate Effect. Foreign Purchases Effect. 10-3 1
AD AS Model Real balances effect: When price level falls, the purchasing power of existing financial balances rises, which can increase spending. Interest rate effect: A decline in price level means lower interest rates that can increase levels of certain types of spending. Foreign purchases effect: When price level falls, other things being equal, U.S. prices will fall relative to foreign prices, which will tend to increase spending on U.S. exports and also decrease import spending in favor of U.S. products that compete with imports. 10-4 AD AS Model Demand Curve Demand AD 10-5 Changes in Demand Determinants of Demand and Multiplier Effect. Changes in: Consumer Spending. Consumer Wealth. Consumer Expectations. Household Debt. Personal Taxes. Investment Spending. Real Interest Rates. 10-6 2
Changes in Demand Expected Returns. About Future Business Conditions. Technology. Degree of Excess Capacity. Business Taxes. Government Spending. Net Export Spending. National Income Abroad. Exchange Rates. 10-7 Changes in Demand Changes in Demand Curve Increase in Demand Decrease in Demand AD 3 AD 2 10-8 Supply supply is a schedule or curve showing the level of real domestic output available at each possible price level. supply in the long run: In the long run the aggregate supply curve is vertical at the economy s full-employment output. The curve is vertical because in the long run resources prices adjust to changes in the price level, leaving no incentive for firms to change their output. 10-9 3
Supply Supply in the Long Run AS LR Long Run Supply 10-10 Supply supply in the short run: The short run aggregate supply curve is upward sloping. The lag between product prices and resource prices makes it profitable for firms to increase output when the price level rises. 10-11 Supply Supply in the Short Run Per-Unit Total Input Cost Production Cost = Units of Output Supply (Short Run) 10-12 0 Q f 4
Changes in Supply Determinants of Supply. Changes in: Input Prices. Domestic Resource Prices. Prices of Imported Resources. Market Power. Productivity. Legal-Institutional Environment. Business Taxes and Subsidies. Government Regulation. 10-13 Changes in Supply Understanding Productivity Productivity = Total Output Total Inputs Total Output 10 5 Total Inputs = = 2 10-14 Changes in Supply Changes in Demand Curve Decrease in Supply AS 3 AS 1 AS 2 Increase in Supply 10-15 5
and Changes in Tabular View Real Output Demanded (Billions) (Index Number) Real Output Supplied (Billions) 10-16 $506 508 510 512 514 92 502 and 108 104 100 96 $513 512 510 507 and Changes in AS 100 92 a b AD 10-17 502 510 514 (Billions of Dollars) and Changes in Increase in Demand AS P 2 Demand-Pull Inflation AD 10-18 Q f Q 1 Q 2 6
and Changes in Decrease in Demand AS P 2 b c a 10-19 Creates a Recession AD 2 Q 1 Q 2 Q f and Changes in Recession and Cyclical Unemployment. Deflation. Downward Price Inflexibility Due to: Fear of Price Wars. Menu Costs. Wage Contracts. Morale, Effort, and Productivity. Efficiency Wages. Minimum Wage. 10-20 and Changes in Decrease in Supply AS 1 AS P 2 Cost-Push Inflation b a AD 10-21 Q 1 Q f 7
and Changes in Increases in Supply Full-Employment With Price-Level Stability AS 1 AS 2 P 3 P 2 a b c AD 2 10-22 Q 1 Q 2 Q 3 demandaggregate supply (AD-AS) model demand Real-balances effect Interest-rate effect Foreign purchases effect Determinants of aggregate demand supply Long-run aggregate supply curve Key Terms Short-run aggregate supply curve Determinants of aggregate supply Productivity price level real output Menu costs Efficiency wages 10-23 10 Appendix The Relationship of the Demand Curve to the Expenditures Model 10-24 8
Expenditures (billions of dollars) Deriving the AD Curve AE 1 (at ) AE 2 (at P 2 ) AE 3 (at P 3 ) As s Increase 45 P 3 P 2 Real GDP Declines 10-25 AD Q 1 Q 2 Q 3 Real Domestic Product, GDP Expenditures Deriving the AD Curve 45 AE 2 (at ) AE 1 (at ) Increase in Expenditures Increase in Demand AD 2 10-26 Q 1 Q 2 Real Domestic Product, GDP Expenditures Deriving the AD Curve 45 AD 2 AE 2 (at ) AE 1 (at ) The Shift in the Demand Curve is a Multiple of the initial Change in Expenditures 10-27 Q 1 Q 2 Real Domestic Product, GDP 9
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