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Aggregate Demand and Aggregate Supply
29
McGraw-Hill/Irwin Copyright © 2012 by The McGraw-Hill Companies, Inc. All rights reserved.
AGENDA Thurs 2/25
• Team Teaching: CH 29
– P3: Connor, Kaleb, Jorge, Zach
– P5: Ms. K
• On Deck: CH 35
– P3: Grant, Hannah, Jason, Pedro
– P5: Ms. K (again)
• HW: Read pp 597-604 Q#6-9
LO1 29-2
QOD #something: PPC
• Assume that the country of Rankinland is
currently in recession.
–Assume that Rankinland produces only food
and clothing.
–Draw a correctly labeled production possibilities
curve for Rankinland.
–Show a point that could represent the current
output combination and label it A.
LO1 29-3
QOD #something: PPC solution
• Graph
LO1 29-4
Aggregate Demand
• Real GDP desired at each price level
• Inverse relationship
Real balances effect-change in the price level. An
increase in the price level reduces the real value of
purchasing power which leads to less
CONSUMPTION.
Interest effect-if we assume the supply of money to
be fixed, higher prices lead to a shortfall of dollars.
Thus the demand for money rises, increasing the
interest rate. This leads to less C and Ig.
Foreign purchases effect-when the U.S. price level
rises, foreigners will buy____goods and Americans
will buy _____ foreign goods.
LO1 29-5
Aggregate Demand
Real domestic output, GDP
Pri
ce le
vel
AD
LO1
0
29-6
Changes in Aggregate Demand
Real domestic output, GDP
Pri
ce l
evel
AD1 AD3
AD2
LO1
0
29-7
Consumer Spending
• Consumer wealth-assets minus liabilities
•More wealth =________.
• Household borrowing
• Consumer expectations
• if we expect our future incomes to rise we
will spend more now.
• If we expect prices to rise in the future we
may also spend now.
• Personal taxes
LO1 29-8
Investment Spending
• Real interest rates-an increase raises borrowing costs.
• Expected returns
• Expectations about future business conditions
• If businesses think the economy will be better
in the future they will forecast higher rates of
return.
• Technology
• Degree of excess capacity-TOO much excess
capacity gives businesses little incentive to INVEST
more.
• Business taxes
LO1 29-9
Government Spending
• Government spending increases
•Aggregate demand increases (as
long as interest rates and tax rates
do not change)
•More transportation projects
• Government spending decreases
•Aggregate demand decreases
• Less military spending, less
unemployment LO1 29-10
Net Export Spending
• National income abroad
• Exchange rates
•Dollar depreciation-???
•Dollar appreciation-???
LO1 29-11
Aggregate Supply
• Total real output produced at each
price level
• Relationship depends on time horizon
• Immediate short run
•Short run-flat up to full emp. then
rises quickly. WHY?
• Long run- Why is it vertical?
LO2 29-12
AS: Immediate Short Run
Real domestic output, GDP
Pri
ce
level
ASISR
Qf
Immediate-short-run
aggregate supply
P1
0
LO2 29-13
Aggregate Supply: Short Run
Real domestic output, GDP
Pri
ce l
evel
0 Qf
AS
Aggregate supply
(short run)
LO2 29-14
Aggregate Supply: Long Run
Real domestic output, GDP
Pri
ce l
evel
ASLR
Qf 0
Long-run
aggregate
supply
LO2 29-15
Changes in Aggregate Supply
• Determinants of aggregate supply
•Shift factors
• Changes raise or lower per-unit
production costs
LO2 29-16
Changes in Aggregate Supply
Real domestic output, GDP
Pri
ce l
evel
AS1
AS3
AS2
0
LO2 29-17
Input Prices
• Domestic resource prices
• Labor
•Capital
• Land
• Prices of imported resources
• Imported oil
•Exchange rates
LO2 29-18
Productivity
• Real output per unit of input
• Increases in productivity reduce
costs
•Decreases in productivity increase
costs
LO2
Per-unit production cost = total input cost
total output
Productivity = total output
total inputs
29-19
Legal-Institutional Environment
• Legal changes alter per-unit costs of output
• Taxes and subsidies
• Extent of government regulation
•More could lead to less agg. supply,
however, if deregulation leads to unfair and
unsafe business practices, it could move
the other direction.
• Also, if agg. demand is strong enough,
would businesses really cut back?
LO2 29-20
Equilibrium
Real domestic output, GDP (billions of dollars)
Pri
ce l
evel
(in
dex n
um
bers
)
100
92
502 510 514
a b
AD
AS
Real Output
Demanded
(Billions)
Price Level
(Index Number)
Real Output
Supplied
(Billions)
$506 108 $513
508 104 512
510 100 510
512 96 507
514 92 502
0
LO3 29-21
Increases in AD: Demand-Pull Inflation
Real domestic output, GDP
Pri
ce l
evel
AD1
AS
P1
P2
Q2 Q1 Qf
AD2
0
LO4 29-22
Why?
• Firms boost investment spending because
they anticipate higher future profits from
investments in new capital.
• Government increases spending for such
programs as national defense.
Decreases in AD: Recession
Real domestic output, GDP
Pri
ce
le
ve
l
AD1
AS
P1
P2
Q1 Q2 Qf
AD2
c
a b
0
LO4 29-24
Prices?
• Sticky prices
• Costs do not necessarily change-menu
costs, minimum wage, wage contracts
• Morale, productivity-wage inflexibility
• Price wars
Decreases in AS: Cost-Push Inflation
Real domestic output, GDP
Pri
ce l
evel
AD
AS1
P1
P2
Q1 Qf
AS2
a
b
0
LO4 29-26
Increases in AS: Full-Employment
Real domestic output, GDP
Pri
ce
le
ve
l
AD1
AS2
P1
P2
Q2 Q1
AS1
b
AD2
c
P3
Q3
a
0
LO4 29-27