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Aggregate Demand and Aggregate Supply. Shows the amount of Real GDP that the private, public and foreign sector collectively desire to purchase at each

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  • Aggregate Demand and Aggregate Supply

  • Shows the amount of Real GDP that the private, public and foreign sector collectively desire to purchase at each possible price levelThe relationship between the price level and the level of Real GDP is inverseSee graph

  • PLGDPRADAggregate Demand Curve

  • Real-Balances EffectWhen the price-level is high households and businesses cannot afford to purchase as much output. When the price-level is low households and businesses can afford to purchase more output.Interest-Rate EffectA higher price-level increases the interest rate which tends to discourage investmentA lower price-level decreases the interest rate which tends to encourage investmentForeign Purchases EffectA higher price-level increases the demand for relatively cheaper importsA lower price-level increases the foreign demand for relatively cheaper U.S. exports

  • There are two parts to a shift in AD:A change in C, IG, G and/or XNA multiplier effect that produces a greater change than the original change in the 4 componentsIncreases in AD = AD Decreases in AD = AD

  • PLGDPRADAD1Increase in Aggregate Demand

  • PLGDPRAD1ADDecrease in Aggregate Demand

  • Consumption (C)Gross Private Investment (IG)Government Spending (G)Net Exports (XN) = Exports - Imports (X M)

  • Household spending is affected by:Consumer wealthMore wealth = more spending (AD shifts )Less wealth = less spending (AD shifts )Consumer expectationsPositive expectations = more spending (AD shifts )Negative expectations = less spending (AD shifts )Household indebtednessLess debt = more spending (AD shifts )More debt = less spending (AD shifts )TaxesLess taxes = more spending (AD shifts )More taxes = less spending (AD shifts )

  • Investment Spending is sensitive to:The Real Interest RateLower Real Interest Rate = More Investment (AD)Higher Real Interest Rate = Less Investment (AD)Expected ReturnsHigher Expected Returns = More Investment (AD)Lower Expected Returns = Less Investment (AD)Expected Returns are influenced byExpectations of future profitabilityTechnologyDegree of Excess Capacity (Existing Stock of Capital)Business TaxesHyperlink to InvestmentDemand.pps

  • More Government Spending (AD)Less Government Spending (AD)

  • Net Exports are sensitive to:Exchange Rates (International value of $)Strong $ = More Imports and Fewer Exports = (AD )Weak $ = Fewer Imports and More Exports = (AD )Relative IncomeStrong Foreign Economies = More Exports = (AD )Weak Foreign Economies = Less Exports = (AD )

  • AD reflects an inverse relationship between PL and GDPR in PL creates real-balance, interest-rate, and foreign purchase effects that explain ADs downward slope in C, IG, G, and/or XN cause in GDPR because they AD.Increase in AD = AD Decrease in AD = AD

  • The level of Real GDP (GDPR) that firms will produce at each Price Level (PL)

  • Long-RunPeriod of time where input prices are completely flexible and adjust to changes in the price-levelIn the long-run, the level of Real GDP supplied is independent of the price-levelShort-RunPeriod of time where input prices are sticky and do not adjust to changes in the price-levelIn the short-run, the level of Real GDP supplied is directly related to the price level

  • The Long-Run Aggregate Supply or LRAS marks the level of full employment in the economy (analogous to PPC)Because input prices are completely flexible in the long-run, changes in price-level do not change firms real profits and therefore do not change firms level of output. This means that the LRAS is vertical at the economys level of full employment

  • PLGDPRLRASYf

  • Because input prices are sticky in the short-run, the SRAS is upward sloping.This reflects the fact that in the short-run, increases in the price-level increase firms profits and create incentives to increase output. As the price-level falls, firms profits drop and this creates an incentive to reduce output.

  • PLGDPRSRAS

  • An increase in SRAS is seen as a shift to the right. SRAS

    A decrease in SRAS is seen as a shift to the left. SRAS

    The key to understanding shifts in SRAS is per unit cost of production

    Per-unit production cost = total input cost/total output

  • PLGDPRSRASSRAS1

  • PLGDPRSRASSRAS1

  • Input Prices

    Productivity

    Legal-Institutional Environment

  • Domestic Resource PricesWages (75% of all business costs) Cost of capitalRaw Materials (commodity prices)Foreign Resource PricesStrong $ = lower foreign resource pricesWeak $ = higher foreign resource pricesMarket PowerMonopolies and cartels that control resources control the price of those resourcesIncreases in Resource Prices = SRAS Decreases in Resource Prices = SRAS

  • Productivity = total output/total inputs

    More productivity = lower unit production cost = SRAS

    Lower productivity = higher unit production cost = SRAS

  • Taxes and SubsidiesTaxes ($ to govt) on business increase per unit production cost = SRAS Subsidies ($ from govt) to business reduce per unit production cost = SRAS Government RegulationGovernment regulation creates a cost of compliance = SRAS Deregulation reduces compliance costs = SRAS

  • The equilibrium of AS & AD determines current output (GDPR) and the price level (PL)

    GDPRPLADSRASLRASYFP

  • Full Employment equilibrium exists where AD intersects SRAS & LRAS at the same point.

    GDPRPLADSRASLRASYFP

  • A recessionary gap exists when equilibrium occurs below full employment output.GDPRPLADSRASLRASYFPY

  • An inflationary gap exists when equilibrium occurs beyond full employment output.GDPRPLADSRASLRASYFPY

  • Consumption (C)C .: AD .: GDPR & PL .: u% & %C .: AD .: GDPR & PL .: u% & % Gross Private Investment (IG)IG .: AD .: GDPR & PL .: u% & %IG .: AD .: GDPR & PL .: u% & % Government Spending (G) G .: AD .: GDPR & PL .: u% & %G .: AD .: GDPR & PL .: u% & % Net Exports (XN)XN .: AD .: GDPR & PL .: u% & %XN .: AD .: GDPR & PL .: u% & %

  • C, IG, G and/or XN .: AD .: GDPR & PL .: u% & %GDPRPLADSRASLRASYFPYAD1P1

  • C, IG, G and/or XN .: AD .: GDPR & PL .: u% & %

    GDPRPLADSRASLRASYFPYAD1P1

  • Input PricesInput Prices .: SRAS .: GDPR & PL .: u% & %Input Prices .: SRAS .: GDPR & PL .: u% & % ProductivityProductivity .: SRAS .: GDPR & PL .: u% & %Productivity .: SRAS .: GDPR & PL .: u% & % Legal-Institutional Environment Deregulation .: SRAS .: GDPR & PL .: u% & %Regulation .: SRAS .: GDPR & PL .: u% & %

  • Input Prices, Productivity, and/or Deregulation .: SRAS .: GDPR & PL .: u% & %GDPRPLADSRASLRASYFPYSRAS1P1

  • Input Prices, Productivity, and/or Regulation .: SRAS .: GDPR & PL .: u% & %GDPRPLADSRASLRASYFPY1SRAS1P1

  • C, IG, G, and/or XN = ADAD .: GDPR & PL .: u% & %AD .: GDPR & PL .: u% & % Input Prices, Productivity, and/or Regulation = SRASSRAS .: GDPR & PL .: u% & %SRAS .: GDPR & PL .: u% & %The AS/AD Model is the most important graph in AP Macroeconomics. KNOW IT!!!

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