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  • 2005 McGraw-Hill Ryerson Ltd. Macroeconomics, Chapter 8 1

    SLIDES PREPARED BY JUDITH SKUCE, GEORGIAN COLLEGE

    Aggregate Demand and Aggregate

    Supply

  • 2005 McGraw-Hill Ryerson Ltd. 2Macroeconomics, Chapter 8

    In this chapter you will learn

    8.1 What determines the shape of the aggregate demand curve and what factors shift the entire curve

    8.2 What determines the shape of the aggregate supply curve, and what factors shift the entire curve

    8.3 How the equilibrium price level and real GDP are determined

    8.4 How the economy arrives at its long run equilibrium

    8.5 Equilibrium vs. full-employment GDP

  • 2005 McGraw-Hill Ryerson Ltd. 3Macroeconomics, Chapter 8

    Chapter 8 Topics

    8.1 Aggregate Demand

    8.2 Aggregate Supply

    8.3 Equilibrium GDP & Changes in

    Equilibrium

    8.4 From the Short Run to the Long Run

    8.5 Equilibrium Versus Full-Employment

    GDP

  • 2005 McGraw-Hill Ryerson Ltd. 4Macroeconomics, Chapter 8

    Aggregate Demand (AD)

    The amounts of real output that buyers

    collectively desire to purchase at each

    possible price level

  • 2005 McGraw-Hill Ryerson Ltd. 5Macroeconomics, Chapter 8

    Aggregate Demand (AD)

    Aggregate Quantity Demanded (Real GDP) and

    the Price Level are inversely related as follows:P

    rice L

    eve

    l

    Real GDP

    AD

    Figure 8 - 1

  • 2005 McGraw-Hill Ryerson Ltd. 6Macroeconomics, Chapter 8

    Aggregate Demand (AD)

    slopes downward because of the

    following effects of a change in price

    level:

    1. Real-balances Effect

    2. Interest-rate Effect

    3. Foreign Trade EffectRemember: these effects are caused

    by price level changes

  • 2005 McGraw-Hill Ryerson Ltd. 7Macroeconomics, Chapter 8

    Pri

    ce

    le

    ve

    l

    Real domestic output, GDP

    AD1

    AD Can Increase

    Changes in Aggregate DemandFigure 8 - 2

  • 2005 McGraw-Hill Ryerson Ltd. 8Macroeconomics, Chapter 8

    AD Can Increase

    shift RIGHT

    AD2

    Pri

    ce

    le

    ve

    l

    Real domestic output, GDP

    AD1

    Changes in Aggregate DemandFigure 8 - 2

  • 2005 McGraw-Hill Ryerson Ltd. 9Macroeconomics, Chapter 8

    Pri

    ce

    le

    ve

    l

    Real domestic output, GDP

    AD1

    AD Can Decrease

    Changes in Aggregate DemandFigure 8 - 2

  • 2005 McGraw-Hill Ryerson Ltd. 10Macroeconomics, Chapter 8

    Pri

    ce

    le

    ve

    l

    Real domestic output, GDP

    AD1

    AD Can Decrease

    shift LEFT

    Changes in Aggregate DemandFigure 8 - 2

    AD3

  • 2005 McGraw-Hill Ryerson Ltd. 11Macroeconomics, Chapter 8

    Determinants of Aggregate Demand

    Consumer Spending

    Consumer wealth

    Consumer expectations

    Taxes

    Household indebtedness

  • 2005 McGraw-Hill Ryerson Ltd. 12Macroeconomics, Chapter 8

    Determinants of Aggregate Demand

    Investment Spending

    Real Interest Rates

    Expected Returns

    Expectations about future business conditions

    Technology

    Degree of excess capacity

    Business taxes

  • 2005 McGraw-Hill Ryerson Ltd. 13Macroeconomics, Chapter 8

    Determinants of Aggregate Demand

    Government Spending

    Net Export Spending

    National Income Abroad

    Exchange Rates

  • 2005 McGraw-Hill Ryerson Ltd. 14Macroeconomics, Chapter 8

    Chapter 8 Topics

    8.1 Aggregate Demand

    8.2 Aggregate Supply

    8.3 Equilibrium GDP & Changes in

    Equilibrium

    8.4 From the Short Run to the Long Run

    8.5 Equilibrium Versus Full-Employment

    GDP

  • 2005 McGraw-Hill Ryerson Ltd. 15Macroeconomics, Chapter 8

    Aggregate Supply

    The level of real domestic output that will

    be produced at each price level

    Production responses to price level

    changes differ in the long run & the short

    run

  • 2005 McGraw-Hill Ryerson Ltd. 16Macroeconomics, Chapter 8

    Aggregate Supply in the Long Run

    in the long run, the aggregate supply curve

    is vertical at the economys full-

    employment output (potential GDP)

    ASLR

    GDPf

    Real domestic

    output, GDP

    Price

    le

    ve

    l

  • 2005 McGraw-Hill Ryerson Ltd. 17Macroeconomics, Chapter 8

    Aggregate Supply in the Long Run

    in the long run, wages & other input prices

    rise or fall to match changes in the price

    level

    changes in the price level do not change

    real profit & there is no change in real

    output

  • 2005 McGraw-Hill Ryerson Ltd. 18Macroeconomics, Chapter 8

    Aggregate Supply in the Short Run

    in reality, nominal wages adjust only slowly to

    changes in the price level

    short-run aggregate supply curve is upward-

    sloping

    GDPf

    Real domestic

    output, GDP

    Price level

    AS

  • 2005 McGraw-Hill Ryerson Ltd. 19Macroeconomics, Chapter 8

    Aggregate Supply in the Short Run

    as the economy expands in the short run, per-unit production costs generally rise

    the extent of the rise depends on where the economy is operating, relative to its capacity an economy operating below its full-employment

    output has idle capital & labourlittle upward pressure on production costs

    when the economy is operating beyond its full-employment output, most available resources are already employedper-unit production costs increase as economy expands

    unless stated otherwise,

    aggregate supply

    refers to AS in the short

    run

  • 2005 McGraw-Hill Ryerson Ltd. 20Macroeconomics, Chapter 8

    Determinants of Aggregate Supply

    1. Change in input prices

    a. Domestic resource price

    b. Price of imported resources

    c. Market power

    2. Change in productivity

    3. Change in legal-institutional environment

    a. Business taxes & subsidies

    b. Government regulation

  • 2005 McGraw-Hill Ryerson Ltd. 21Macroeconomics, Chapter 8

    Chapter 8 Topics

    8.1 Aggregate Demand

    8.2 Aggregate Supply

    8.3 Equilibrium GDP & Changes in

    Equilibrium

    8.4 From the Short Run to the Long Run

    8.5 Equilibrium Versus Full-Employment

    GDP

  • 2005 McGraw-Hill Ryerson Ltd. 22Macroeconomics, Chapter 8

    Equilibrium GDP

    Equilibrium occurs at the price level that

    equalizes the amount of real output

    demanded & supplied

    A price level too low would mean AD>AS,

    putting upward pressure on prices across

    the economy

  • 2005 McGraw-Hill Ryerson Ltd. 23Macroeconomics, Chapter 8

    Price Level Too Low

    AD

    ASPriceLevel

    Real

    GDP

    PL1

    AS1 AD1

    Figure 8-6

    upward

    pressure

  • 2005 McGraw-Hill Ryerson Ltd. 24Macroeconomics, Chapter 8

    Equilibrium GDP

    similarly, a price level too high would

    mean AD

  • 2005 McGraw-Hill Ryerson Ltd. 25Macroeconomics, Chapter 8

    AD

    ASPriceLevel

    Real

    GDP

    PL2

    AS2

    Price Level Too High

    AD2

    Figure 8-6

    downwar

    d

    pressure

  • 2005 McGraw-Hill Ryerson Ltd. 26Macroeconomics, Chapter 8

    Changes in Equilibrium

    Are caused by changes (shifts) in AD

    and/or AS

  • 2005 McGraw-Hill Ryerson Ltd. 27Macroeconomics, Chapter 8

    Increases in AD

    for any initial increase in aggregate

    demand, the resulting increase in real

    output will be smaller the greater is the

    increase in the price level

    demand-pull inflation

  • 2005 McGraw-Hill Ryerson Ltd. 28Macroeconomics, Chapter 8

    Increases in AD

    AS

    AD1

    Real GDP

    Pri

    ce le

    vel

    AD2

    GDPf

    P1

    GDP2

    P2

    GDP1

    Figure 8-7

    output does not

    increase all the way

    to GDP1 because of

    inflation

  • 2005 McGraw-Hill Ryerson Ltd. 29Macroeconomics, Chapter 8

    Decreases in AD

    Deflation is a rarity in the Canadian economy

    Real output takes the full brunt of the decline in

    AD because product prices are sticky in the

    short run

    wage contracts

    morale, effort, & productivity

    minimum wage

    menu costs

    fear of price wars

  • 2005 McGraw-Hill Ryerson Ltd. 30Macroeconomics, Chapter 8

    Decreases in AD

    AS

    AD1

    Real GDP

    Pri

    ce le

    vel

    AD2

    GDPf

    P1

    GDP1

    Figure 8-8prices are sticky

    downwards

  • 2005 McGraw-Hill Ryerson Ltd. 31Macroeconomics, Chapter 8

    Decreases in AS: Cost-Push Inflation

    effects of a leftward shift in AS are doubly

    bad

    output decreases

    price level increases

  • 2005 McGraw-Hill Ryerson Ltd. 32Macroeconomics, Chapter 8

    Decreases in AS

    AS1

    AD1

    Real GDP

    Pri

    ce le

    vel

    GDPf

    P1

    GDP2

    P2

    Figure 8-9

    AS2

  • 2005 McGraw-Hill Ryerson Ltd. 33Macroeconomics, Chapter 8

    Increases in AS

    increases in AD should normally lead to

    inflation

    recently, productivity growth has shifted

    the long-run AS curve to the right

  • 2005 McGraw-Hill Ryerson Ltd. 34Macroeconomics, Chapter 8

    Increases in AS

    AS1

    AD1Real GDP

    Pri

    ce le

    vel

    GDP1

    P1

    Figure 8-10

    AD2

    AS2

    P2

    GDP3

    P3

    GDP2