macroeconomics ch 9

8/11/2019 Macroeconomics Ch 9

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Keywords: P lanned & Actua l Investment

Planned investment (Ip) is the amount of investment firms plan to

undertake during a year = Total business expenditures on plants and

equipments + planned production of inventories (goods that firms

are planning to keep as inventories for the future).

Actual investment (I) is the amount of investment actually

undertaken during a year = planned investment + unplanned changes

in inventories = (Ip) + unplanned changes in inventories .

(I) (Ip) = unplanned changes in inventories can be either positive

(unintended inventory accumulation: actual inventories > planned

inventoriesthere was a lack of demand) or negative (unintended

inventory decumulation: actual inventories < planned inventories

there was an excess of demandyou had to sell goods that you had

been planning to keep as inventories for the future).


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A g g r e g a t e D e m a n d ( A D ) - D e f i n i t i o n

In macroeconomics, the focus is on the demand and supply of all goods and

services produced by an economy. Accordingly, the demand for all individual

goods and services is combined and referred to as aggregate demand. AD is

the total amount of goods and services demanded in the economy at a given

overall price level and in a given time period. AD correspond to the total value

of REAL GDP that all sectors of the economy are willing to purchase at a given

overall price level and in a given time period.


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A g g r e g a t e D e m a n d ( c o n )

AD = C + Iplanned+ G + (EXIM)

Recall: GDP (Y), by the expenditure

approach is:

Y = C + I + G + (EXIM)


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A g g r e g a t e D e m a n d ( c o n )

If firms produce goods that NEITHER THE FIRM NOR THE

CUSTOMERS WERE DEMANDING, those goods are counted

in GDP, as unintended inventory accumulation, but they are

not part of aggregate demand, because, clearly, NOBODY

desired them.

The difference between AD and GDP = unintended

inventory accumulation.


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Aggregate Demand - Components

Aggregate demand is composed of the sum of aggregate expenditures:

AD= Expenditures = C + Iplanned+ G +(X - M)

Where:

C = Consumers' expenditures on goods and services.

Iplanned= The amount of investment firms plan to undertake during a year.

G = Governments expenditures on publicly provided goods and services.

X = Exports of goods and services.

M = Imports of goods and services.


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Aggregate Demand Curve

Aggregate demand is represented

by the aggregate-demand

curve, which represents the

quantity of goods and services

that will be demanded

(purchased) at different price

levels. This is the demand for

the gross domestic product

(GDP) at different price levels.


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1) The Real Balance Effect

A higher aggregate price level (higher inflation) reduces thepurchasing power of householdsand companies wealththeywill feel poorertheir spending will .

2) The Interest Rate EffectA higher aggregate price level (higher inflation) Nominal

interest rate (nominal interest rate = real interest rate + inflationrate )savingsspending .

3) The Foreign Purchases Effect

If prices rise in the homeland, exports decrease and importsincrease, so Xnetdecreases.

Three Reasons why the AD Curve Slopes Down


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When a change in the price level

causes equilibrium GDP to change,

we move along the AD curve.

Whenever anything other than the

price level causes equilibrium GDP to

change, the AD curve itself shifts.


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S h i f t F a c t o r s o f t h e A D C u r v e

Shifts in the aggregate demand curve are not caused by changes inthe price level. Instead, they might be caused by ANY changes:

1) In the demand for consumption goods and services (C).

2) In investment spending (I).

3) In the government's demand for goods and services (G).

4) In the demand for net exports (EXIM).

5) In fiscal policy [Tax and/or government spendingAD].

6) In monetary policy [Federal Reserve money supply interest rates spendingAD].

7) In consumer confidence or expectations.

8) In consumer wealth.

9) In the stock of physical capital (factors of production, such as

machinery, buildings, or computers..).

S h i f f h A D C ( )


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S h i f t s o f t h e A D C u r v e ( c o m )

In general, any expansionary policy

shifts the aggregate demand curve to

the right while any contractionarypolicy shifts the aggregate demand

curve to the left.

A shift to the right of the aggregate

demand curve. from AD to AD, means

that at the same price levels the

quantity demanded of real GDP

has increased.

A shift to the left of the aggregate

demand curve, from AD to AD, means

that at the same price levels the

quantity demanded of real GDP

has decreased.


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Aggregate Supply (AS)

Aggregate Supplyis the total supply of goods and services that firms in

a national economy plan on selling during a specific time period. It is

the total amount of goods and services that firms are willing to sell at

a given price level in an economy. Aggregate supply is represented

by the aggregate- supply curve, which represents the quantity of

real GDP that is supplied by the economy at different price levels.


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The Short Run Aggregate Supply Curve

Classical economists believe that in the

short run the aggregate supply curve is

upward sloping. In the short run an

increase in aggregate demand may lead

to an increase in output, but there will

also be an increase in the price level.


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The Long Run Aggregate Supply Curve

Classical economists believe that in the long run the

level of real production (GDP) is maintained

regardless of the price level, which creates a vertical,

or perfectly elastic, aggregate supply curve. This

relation results due to flexible prices, which ensure

that resources markets maintain equilibrium balance

at full employment (which corresponds to the natural

unemployment rate) . Should the price level rise or fall,

wages and resource prices adjust to ensure that

quantity demanded equals quantity supplied in

resource markets.


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The Keynesian Aggregate Supply Curve

John Maynard Keynes argued that prices and wages were

sticky, in particular they were inflexible downward due to the

existence of unions and contracts between employers and

employees. He argued that in a world of excess capacity, an increase

in aggregate demand will not impact prices (as the classical

economists thought) but will instead impact real GDP.

The assumptions of the Keynesian model are the same as the

classical model except for two important differences: prices and

wages are sticky, and excess capacity exists in the economy.


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The Keynesian Aggregate Supply Curve (con)

Within the Keynesian framework,

the aggregate supply (AS) curve

is sketched horizontally. This is

done because prices are sticky

in the short run, represented by

the flat line (prices dont

change). Because this onlyoccurs in the very short run, we

label this the short run

aggregate supply curve (SRAS1).


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New Keynesians realized thatprices and wages were notperfectly sticky, even in theshort run. Because of thisthey developed a new SRAS

curve which was upwardsloping. This allowed forsome price and wagestickiness, but also allowed

for some flexibility. Thisupward sloping SRAS2 supplycurve has become thestandard SRAS curve used ineconomic analysis.


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We may also see charts thatshow two SRAS curves, onehorizontal, and one upwardsloping. Generally thehorizontal curve shows thevery short run, and the upwardsloping shows the short tomedium run aggregate supplycurve. In the long run, we endup back with the classicalmodel (LRAS), so the threedifferent aggregate supplycurves show us how prices andreal GDP will change overshort, medium, and long timeframes.

T h A D A S M d l


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T h e A D A S M o d e lThe ADAS or aggregate demand

aggregate supply model is a

macroeconomic model that

explains price level and output

(GDP) through the relationship of

aggregate demand and aggregate

supply. It is based on the theory of

John Maynard Keynes presented in

his work The General Theory of

Employment, Interest, and Money.

macroeconomics ch 9

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