Chapter 8 Aggregate Demand and Aggregate Supply

8/9/2019 Chapter 8 Aggregate Demand and Aggregate Supply

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Chapter 8

Aggregate Demand andAggregate Supply

Issues In Economics Today, 4eGuell

McGraw-Hill/Irwin Copyright 2008 by The McGraw-Hill Companies, Inc. All rights res


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Chapter Outline

Aggregate Demand Aggregate Supply

Shifts in Aggregate Demand andAggregate Supply Causes of Inflation Supply-Side Economics How the Government can Influence (but

probably not control) the economy


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Aggregate Demand

Aggregate Demand : the amounts of real domestic output which domesticconsumers, businesses,

governments, and foreign buyerscollectively will desire to purchase ateach possible price level


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Why Aggregate Demandis Downward Sloping

Real Balances Effect Because higher prices reduce real spending

power, prices and output are negatively related. Foreign Purchases Effect

When domestic prices are high, we will exportless to foreign buyers and we will import morefrom foreign producers. Therefore higher pricesleads to less domestic output.

Interest Rate Effect higher prices lead to inflation which leads to less

borrowing and a lowering of RGDP


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Aggregate Supply

Aggregate Supply : the level of realdomestic output available at each

possible price level


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Figure 2 The Aggregate Supply Curve

RGDP

PI

Keynesian Range

ClassicalRange

IntermediateRange

AS


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The Ranges of AS

Keynesian Range Large amounts of unemployment make it so that

increases in aggregate demand have no affect on

wages or prices. Classical Range Full employment makes it so that increases in

aggregate demand only increase wages or prices.

Intermediate Range Some sectors of the economy reach fullemployment more quickly than others.


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Variables that Shift Aggregate Demand

Taxes Interest Rates

Confidence Strength of the Dollar Government Spending


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Determinants of ADVariable GDP

ComponentC,I,G,X

Effect of an

increase on AD

Effect of a

decrease on AD

Taxes C,I Decrease soAD

Interest Rates C,I Decrease soAD

Confidence C,I Increase soAD =>

Decrease soAD

Decrease soAD


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Figure 3 AD Increases

AD

AS

AD

RGDP

PI

PI*

RGDP*

PI

RGDP


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Figure 4 AD Decreases

AD

AS

AD

RGDP

PI

PI*

RGDP*

PI

RGDP


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Variables that Shift AS

Input Prices Productivity

Government Regulation


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Determinants of AS

Variable Effect of anIncrease on AS

Effect of anDecrease on AS

Input Prices Decrease soAS

Increase soAS

Productivity Increase so

AS

Decrease so

ASGovernmentRegulation

Decrease soAS

Increase soAS


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Figure 5 Increase in AS

AS

AD

RGDP

PI

PI*

RGDP*

AS

PI

RGDP


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Figure 6 Decrease in AS

RGDP

AS

AD

PI

PI*

RGDP*

AS

PI

RGDP


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Causes of Inflation

Demand Pull Inflation : inflation causedby an increase in aggregate demand

Cost Push Inflation : inflation causedby a decrease in aggregate supply


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Government Influence:Aggregate Demand

Government can influence economicactivity with aggregate demand sidepolicies affecting: Taxes Government Spending Interest Rates


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Government Influence:Aggregate Supply

Government can influence economic activitywith aggregate supply side policies affecting input costs (labor and wage) reducing regulation Increase incentives to

Work Take Risks

The actions are call Supply Side Economics


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Chapter 8 Aggregate Demand and Aggregate Supply