3.3 Macroeconomic Models

Tatiana Gema

Aggregate Demand A schedule or curve that shows the amounts

of real output that buyers collectively desire to purchase at each price level.

Price and amount of real GDP demanded are inversely related.

Slopes downward because: - real-balances effect:

• caused by changes in price level• Higher price reduces publics purchasing power and

vise-versa

Continued… interest-rate effect:

• assume supply of money is fixed

• higher price level increases the demand for money and vise-versa

• Since money supply is fixed an increase in money demand will cause interest rates to go up.

Foreign purchases effect:• When both U.S and foreign price level rises and

exchange rates do not respond quickly, it causes U.S and foreigners to buy less of each others goods

• Exports falls and imports rise

AD Graph

Aggregate Supply

A schedule or curve showing the level of real output that firms will produce at each price level.

Long Run: wages and resource prices match price level

Short Run: wages and resource prices do not respond to price level changes

Long Run

Supply curve is vertical showing wages respond completely to price level change at full employment output.

Price level change do not alter the amount of real GDP.

Price level changes do not affect firms profits and does not cause firms to alter their output

Short Run

Supply curve is upward sloping. A rise in price causes a increase in

real output and vice-versa.

Keynesian vs. Neoclassical Neoclassical:

supply creates its own demand act of producing goods generates income equal

to the value of the goods produced There will always be full-employment because

market is always fixing itself

Keynesian: Explained why unemployment can occur Not all income is spent at the same time its produced Unsold goods would accumulated in warehouses

causing reductions in outputs and firms to eliminate workers

Government should play a role in the economy

Full employment level of national income

National Income is the level of total output, expenditure or income of an economy over a period of time.

measure National income by GDP (a measure of all domestic production)

employment level of National Income means the level of total output attained when unemployment is at a socially acceptable level.

Equilibrium level of national income

When short run aggregate supply is perfectly elastic, any change in aggregate demand will feed straight through to a change in the equilibrium level of real national output.

Inflationary Gap Amount by which an economies

aggregate expenditures at the full employment GDP exceed those just necessary to achieve full employment.

Moves above equilibrium point Effect= excessive spending that will

pull up output prices Graph on pg. 186

Recessionary Gap

Amount by which aggregate expenditures at the full employment GDP fall short of those required to achieve full employment GDP.

Caused by insufficient total spending Graph on pg.186

Business Cycle

Continued… Peak: business activity reached a

temporary maximum. Recession: a period of decline in total

output, income, employment, and trade.

Trough: output and unemployment are at their lowest levels.

Recovery: output and employment rise toward full employment.