Aggregate Demand and Aggregate Supply. Used to explain or predict the effects of macroeconomic...
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How can we analyze economic fluctuations? Aggregate Demand and Aggregate Supply
Aggregate Demand and Aggregate Supply. Used to explain or predict the effects of macroeconomic events or policies on equilibrium price and output Effect:
Used to explain or predict the effects of macroeconomic events
or policies on equilibrium price and output Effect: Uncertainty
causing less consumption and investment Lower price and gdp Event:
Tsunamis Effect: More Governmental intervention to spend more money
Higher price and gdp Event: Government Intervention
Slide 3
Shows the relationship between PRICE LEVELS (y) And REAL GDP
(X) the total demand for domestic goods in an economy GDP = C
onsumption + I nvestment + G overnment Spending + E xports I
mports
Slide 4
Slide 5
1) Foreign Sector Substitution effect: If prices rise
domestically Look internationally If prices fall domestically Buy
more domestically
Slide 6
2) Interest rate effect: If prices rise Need to borrow more
Interest rates rise Investment falls Consumption falls If prices
fall Need to borrow less Interest rates fall Investment increases
Consumption increases
Slide 7
3) The Wealth effect: If price rises The purchasing power falls
The quantity of domestic output demanded falls
Slide 8
Changing any of the components: Consumption Investment
Government Spending Exports Imports
Slide 9
Consumption will Investment will Increase AD ifDecrease AD if
More wealthLess wealth More optimisticLess optimistic Less
taxesMore taxes Increase AD ifDecrease AD if Lower real interest
rateHigher real interest rate Higher expected returnsLower expected
returns Due to future expectations about profitability
Slide 10
GOVERNMENT SPENDING WILLNET EXPORTS Increase AD with more
spending Decrease AD with less spending Increase AD if Decrease AD
if Weak Domestic Currency (more exports, less imports) Strong
Domestic Currency (less exports, more imports) Strong Foreign
Economies (Export more) Weak Foreign Economies (we export
less)
Slide 11
INCREASE OF AD (RIGHT) DECREASE IN AD (LEFT)
Slide 12
As a team of economists, you receive $1 million dollars to help
bolster the Japanese economy. Strategize how you will use this
money to increase your component of Aggregate Demand after the
tsunami and earthquake in Japan. How will your response rebuild the
economy?
Slide 13
MPC in Economics means Marginal Propensity to Consume. This
refers to the means of measuring the proportion of how much is
spent to how much is saved. This is known in business but is
actually commonly used by individuals on their everyday lives and
on how they budget.
Slide 14
Change to any component of AD (C + Ig + G + Xn) has a ripple
effect Results in a multiplied effect on GDP Important as a small
change in spending leads to a large change in GDP Calculated by: 1
or 1 MPS 1- MPC
Slide 15
Examples: 1/MPS.25 MPS change = multiplier of 4.33 MPS change =
multiplier of 3 MPC of.75 = 1/.25 (MPS) = multiplier of 4 If gov
spending increases by $20 X 4 = GDP increases by $80
Slide 16
PL (Y) And Real GDP (x) the summation of all individual supply
curves in an economy or total output in an economy
Slide 17
SHORT RUN: PD. OF TIME WITH STICKY PRICES AND WAGES LONG RUN:
PD. OF TIME WHEN PRICES AND WAGES ARE FLEXIBLE Input $ do not
adjust to changes in the Price Level Keynesian school Input $ are
flexible and adjust to changes in Price Level Classical school
Slide 18
PL GDP R SRAS As prices increase: Firms produce more for a
greater profit As prices decrease: sales will fall, and producers
produce less
Slide 19
P roductivity (technology) I nput Prices L aws, regulations,
taxes E xpected Inflation
Slide 20
Productivity will Input Prices will Increase SRAS ifDecrease
SRAS if Improvements in technology Natural Disasters destroy
resources Novel Techniques introduced Labor Force is reduced in
size because of strikes or epidemics Increase SRAS ifDecrease SRAS
if Lower cost of productionHigher cost of production
Slide 21
Laws and Regulations will Expected Inflation will Increase SRAS
ifDecrease SRAS if Lower taxesHigher taxes Lower wagesHigher wages
Increase SRAS ifDecrease SRAS if Prices are expected to
Slide 22
DECREASE IN INPUT COSTSINCREASE IN INPUT COSTS PL GDP R SRAS
SRAS 1 PL GDP R SRAS SRAS 1 PL
Slide 23
GDP R LRAS YfYf
Slide 24
LIKE THE PPF In the Long run, we are at Full Employment (3-5%
unemployment) CHANGE IN TECHNOLOGY CHANGE IN LABOR PRODUCTIVITY
Increase the Human Capital, or skill level of the workers CHANGE IN
CAPITAL
Slide 25
NumberScenario 1The government increases expenditures on
education. 2There is an increase in the price of oil. 3Businesses
face a pollution tax for their externalities. 4The value of the yen
increases. 5New technology and better education increase
productivity. 6Interest rates fall with an increase in the money
supply (show the effect on AD only) 7There is an increase in
investment across the nation after the tsunami. 8Unions become more
aggressive and wage rates increase. 9Consumers (not producers)
become more confident about the future. 10Honda cars become
extremely popular globally.
Intersection between SRAS and AD determines price level (PL)
and the current output (GDP) GDP R PL AD SRASLRAS Yf P Full
employment = Yf, any distance away from FE shows unemployment
Slide 28
Equilibrium occurs to the right of full employment GDP R PL AD
SRASLRAS YFYF P Y
Slide 29
Equilibrium occurs to the left of full employment GDP R PL AD
SRAS LRAS Yf P Y
Slide 30
Basic Assumptions: 1) Inverse relationship between inflation
and unemployment 2) If inflation demand pull 3) If deflation
recession 4) Movement along curve changes during business cycle as
represented by an increase or decrease of AD
Slide 31
i u PC 4% 2% 7%5%....... Shows the relationship between
inflation and unemployment
Slide 32
Effect: Causes movements along the curve GDP R PL AD SRAS LRAS
YFYF P Y AD 1 P1P1 SRPC i u i% u%unun i 1i 1 ....
Slide 33
Effect: causes a rightward shift of the Short-run Phillips
Curve Stagflation: Increase in Price and Decrease in Output (1970s)
GDP R PL AD SRAS LRAS YFYF P Y1Y1 SRAS 1 P1P1 u% i SRPC LRPC unun i
u1u1 SRPC 1 i1i1....
Slide 34
i u SRPC 4% 2% 7%5%.............. SRPC 1 An increase in the
SRPC arises from a leftward shift of the SRAS
Slide 35
AD Slides it up or down, up or down, up or down, SRAS Shifts it
in or out Inflation, Unemployment
Slide 36
The economy can adjust to inflation in the long run due to real
wages. The LRPC is vertical at the Natural Rate of Unemployment
Increases in the unemployment rate because of more unemployment
compensation rightward shift Decreases in the unemployment rate
because of less unemployment compensation leftward shift
Slide 37
SRPC 1 LRPC 1 % uN%uN% A BC 2 % u% SRPC 2 inflation
unemployment A movement from A to B arises from a cyclical change.
A shift from SRPC 1 to SRPC 2 arises from a decrease in the SRAS
curve.
Slide 38
1)Assume an economy is operating at full employment. A major
political event stops the delivery of foreign oil to the country.
a) Draw the Aggregate Model to show how this event affects
macroeconomic equilibrium. (Include the SRAS, AD, and LRAS curves.)
b) Show how this change affects the Short Run Phillips Curve. c)
Because of this event, the government is unable to provide
unemployment compensation for federal workers. Show the change on
the LRPC. Use 4% as the original LRPC.