C h a p t e r twenty-four © 2006 Prentice Hall Business Publishing Economics R. Glenn Hubbard, Anthony Patrick O’Brien—1 st ed. Prepared by: Fernando &

c h a p t e rc h a p t e r

twenty-fourtwenty-four

© 2006 Prentice Hall Business Publishing Economics R. Glenn Hubbard, Anthony Patrick O’Brien—1 st ed.

Prepared by: Fernando & Yvonn Quijano

Aggregate Demand andAggregate Supply Analysis

Modified by Chris Ball


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After studying this chapter, you should be able to:

Discuss the determinants of aggregate demand, and distinguish between a movement along the aggregate demand curve and a shift of the curve.

Discuss the determinants of aggregate supply, and distinguish between a movement along the short-run aggregate supply curve and a shift of the curve.

Use the aggregate demand and aggregate supply model to illustrate the difference between short-run and long-run macroeconomic equilibrium.

Use the dynamic aggregate demand and aggregate supply model to analyze macroeconomic conditions.

Caterpillar Recovers Slowly from the 2001 Recession

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Caterpillar is a multinational corporation, so its sales are affected by factors that are unimportant for firms that sell only in the domestic markets.


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Aggregate demand and aggregate supply model A model that explains short-run fluctuations in real GDP and the price level.

Aggregate demand curve (AD) A curve showing the relationship between the price level and the quantity of real GDP demanded by households, firms, and the government.

Short-run aggregate supply curve (SRAS) A curve showing the relationship in the short run between the price level and the quantity of real GDP supplied by firms.

Aggregate Demand

LEARNING OBJECTIVE1


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Aggregate Demand

24 - 1

Aggregate Demand and Aggregate Supply


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Aggregate Demand

Why is the Aggregate Demand Curve Downward Sloping?

Y = C + I + G + NX

THE WEALTH EFFECT: HOW A CHANGE IN THE PRICE

LEVEL AFFECTS CONSUMPTION

THE INTEREST-RATE EFFECT: HOW A CHANGE IN THE

PRICE LEVEL AFFECTS INVESTMENT

THE INTERNATIONAL-TRADE EFFECT: HOW A CHANGE IN

THE PRICE LEVEL AFFECTS NET EXPORTS

Be Clear Why the Aggregate Demand Curve Is Downward Sloping


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Aggregate Demand

Shifts of the Aggregate Demand Curve versus Movements Along It

The Variables That Shift the Aggregate Demand Curve

CHANGES IN GOVERNMENT POLICIES

CHANGES IN THE EXPECTATIONS OF

HOUSEHOLDS AND FIRMS

CHANGES IN FOREIGN VARIABLES


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Monetary Policy and Economic Activity

Monetary Policy also affects Aggregate Demand, but does so “indirectly” by affecting the interest rate.

A Summary of How Monetary Policy Works


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Movements along the Aggregate Demand Curve versus Shifts of the Aggregate Demand Curve

24 - 1

LEARNING OBJECTIVE1


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Aggregate Demand


Variables That Shift the Aggregate Demand Curve

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Aggregate Demand


Variables That Shift the Aggregate Demand Curve

24 – 1


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Aggregate Supply

LEARNING OBJECTIVE2

The Long-Run Aggregate Supply Curve

Long-run aggregate supply (LRAS) A curve showing the relationship in the long run between the price level and the quantity of real GDP supplied.


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Aggregate Supply

The Long-Run Aggregate Supply Curve24 - 2

The Long-Run Aggregate Supply Curve


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Aggregate Supply

The Short-Run Aggregate Supply Curve

1. CONTRACTS MAKE SOME WAGES AND PRICES “STICKY”

2. FIRMS ARE OFTEN SLOW TO ADJUST WAGES

3. MENU COSTS MAKE SOME PRICES STICKY

Menu costs The costs to firms of changing prices

The three most common explanations as to why a short-run aggregate supply curve slopes upward include:


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Aggregate Supply

Shifts of the Short-Run Aggregate Supply Curve versus Movements Along It

INCREASES IN THE LABOR FORCE AND IN THE

CAPITAL STOCK

TECHNOLOGICAL CHANGE

EXPECTED CHANGES IN THE FUTURE PRICE LEVEL

Variables That Shift the Short-Run Aggregate Supply Curve


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Aggregate Supply

How Expectations of the Future Price Level Affect the Short-Run Aggregate Supply Curve

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Aggregate Supply


ADJUSTMENTS OF WORKERS AND FIRMS TO

ERRORS IN PAST EXPECTATIONS ABOUT THE

PRICE LEVEL

UNEXPECTED CHANGES IN THE PRICE OF AN

IMPORTANT NATURAL RESOURCE

Supply shock An unexpected event

that causes the short-run aggregate

supply curve to shift.


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Macroeconomic Equilibrium in the Long Run and the Short Run

LEARNING OBJECTIVE3


24 – 2


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Macroeconomic Equilibriumin the Long Run and the Short Run


24 – 2


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24 - 4Long-Run Macroeconomic Equilibrium


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Recessions, Expansions, and Supply Shocks

Because the full analysis of the aggregate demand and aggregate supply model can be complicated, we begin with a simplified case, using two assumptions:

1. The economy has not been experiencing any inflation. The price level is currently 100, and workers and firms expect it to remain at 100 in the future.

2. The economy is not experiencing any long-run growth. Potential real GDP is $10.0 trillion and will remain at that level in the future.


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RECESSION

The Short-Run and Long-RunEffects of a Decrease inAggregate Demand

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EXPANSION

The Short-Run and Long-RunEffects of an Increase inAggregate Demand

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SUPPLY SHOCK

The Short-Run and Long-Run Effects of a Supply Shock

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SUPPLY SHOCK

Stagflation A combination of inflation and recession, usually resulting from a supply shock.


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A Dynamic Aggregate Demand and Aggregate Supply Model

We can create a dynamic aggregate demand and aggregate supply model by making three changes to the basic model:

Potential real GDP increases continually, shifting the

long-run aggregate supply curve (LRAS) to the right.

During most years, the aggregate demand curve

(AD) will be shifting to the right.

Except during periods when workers and firms

expect high rates of inflation, the short-run aggregate

supply curve (SRAS) will be shifting to the right.

LEARNING OBJECTIVE4


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A Dynamic Aggregate Demandand Aggregate Supply Model

24 - 8An Increase in Potential Real GDP


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A Dynamic Aggregate Demandand Aggregate Supply Model

Using Dynamic Aggregate Demand and Aggregate Supply to Understand Inflation

24 - 9

What Is the Usual Cause of Inflation?

Documents

C h a p t e r twenty-four © 2006 Prentice Hall Business Publishing Economics R. Glenn Hubbard, Anthony Patrick O’Brien—1 st ed. Prepared by: Fernando &