Aggregate Demand and Aggregate Supply

29

McGraw-Hill/Irwin Copyright © 2012 by The McGraw-Hill Companies, Inc. All rights reserved.

AGENDA Thurs 2/25

• Team Teaching: CH 29

– P3: Connor, Kaleb, Jorge, Zach

– P5: Ms. K

• On Deck: CH 35

– P3: Grant, Hannah, Jason, Pedro

– P5: Ms. K (again)

• HW: Read pp 597-604 Q#6-9

LO1 29-2

QOD #something: PPC

• Assume that the country of Rankinland is

currently in recession.

–Assume that Rankinland produces only food

and clothing.

–Draw a correctly labeled production possibilities

curve for Rankinland.

–Show a point that could represent the current

output combination and label it A.

LO1 29-3

QOD #something: PPC solution

• Graph

LO1 29-4

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

Aggregate Demand

Real domestic output, GDP

Pri

ce le

vel

AD

LO1

0

29-6

Changes in Aggregate Demand

Real domestic output, GDP

Pri

ce l

evel

AD1 AD3

AD2

LO1

0

29-7

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

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

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 LO1 29-10

Net Export Spending

• National income abroad

• Exchange rates

•Dollar depreciation-???

•Dollar appreciation-???

LO1 29-11

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?

LO2 29-12

AS: Immediate Short Run

Real domestic output, GDP

Pri

ce

level

ASISR

Qf

Immediate-short-run

aggregate supply

P1

0

LO2 29-13

Aggregate Supply: Short Run

Real domestic output, GDP

Pri

ce l

evel

0 Qf

AS

Aggregate supply

(short run)

LO2 29-14

Aggregate Supply: Long Run

Real domestic output, GDP

Pri

ce l

evel

ASLR

Qf 0

Long-run

aggregate

supply

LO2 29-15

Changes in Aggregate Supply

• Determinants of aggregate supply

•Shift factors

• Changes raise or lower per-unit

production costs

LO2 29-16

Changes in Aggregate Supply

Real domestic output, GDP

Pri

ce l

evel

AS1

AS3

AS2

0

LO2 29-17

Input Prices

• Domestic resource prices

• Labor

•Capital

• Land

• Prices of imported resources

• Imported oil

•Exchange rates

LO2 29-18

Productivity

• Real output per unit of input

• Increases in productivity reduce

costs

•Decreases in productivity increase

costs

LO2

Per-unit production cost = total input cost

total output

Productivity = total output

total inputs

29-19

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?

LO2 29-20

Equilibrium

Real domestic output, GDP (billions of dollars)

Pri

ce l

evel

(in

dex n

um

bers

)

100

92

502 510 514

a b

AD

AS

Real Output

Demanded

(Billions)

Price Level

(Index Number)

Real Output

Supplied

(Billions)

$506 108 $513

508 104 512

510 100 510

512 96 507

514 92 502

0

LO3 29-21

Increases in AD: Demand-Pull Inflation

Real domestic output, GDP

Pri

ce l

evel

AD1

AS

P1

P2

Q2 Q1 Qf

AD2

0

LO4 29-22

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.

Decreases in AD: Recession

Real domestic output, GDP

Pri

ce

le

ve

l

AD1

AS

P1

P2

Q1 Q2 Qf

AD2

c

a b

0

LO4 29-24

Prices?

• Sticky prices

• Costs do not necessarily change-menu

costs, minimum wage, wage contracts

• Morale, productivity-wage inflexibility

• Price wars

Decreases in AS: Cost-Push Inflation

Real domestic output, GDP

Pri

ce l

evel

AD

AS1

P1

P2

Q1 Qf

AS2

a

b

0

LO4 29-26

Increases in AS: Full-Employment

Real domestic output, GDP

Pri

ce

le

ve

l

AD1

AS2

P1

P2

Q2 Q1

AS1

b

AD2

c

P3

Q3

a

0

LO4 29-27