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Aggregate Demand and Supply

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Tammy Brown

on 9 April 2012

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Transcript of Aggregate Demand and Supply

Aggregate Supply and Demand
Aggregate Demand
Aggregate Supply
the Most important Macroeconomic model in AP Macroeconomics
Shows the amount of Real GDP that the private, public and foreign sector collectively desire to purchase at each possible price level
The relationship between the price level and the level of Real GDP is inverse
Three Reasons AD is downward sloping
Real-Balances Effect
When the price-level is high households and businesses cannot afford to purchase as much output.
When the price-level is low households and businesses can afford to purchase more output
Interest-Rate Effect
A higher price-level increases the interest rate which tends to discourage investment
A lower price-level decreases the interest rate which tends to encourage investment
Foreign Purchases Effect
A higher price-level increases the demand for relatively cheaper imports
A lower price-level increases the foreign demand for relatively cheaper U.S. exports
Determinants of AD
Consumption (C)
Gross Private Investment (IG)
Government Spending (G)
Net Exports (XN) = Exports - Imports (X – M)
Consumer wealth
+ wealth = + spending (AD shifts R)
- wealth = - spending (AD shifts L)
Investment Spending is sensitive to:
The Real Interest Rate
Lower Real Interest Rate = More Investment (AD R)
Higher Real Interest Rate = Less Investment (AD L)
More Government Spending (AD R)
Less Government Spending (AD L)
Net Exports are sensitive to:

Exchange Rates (International value of $)
Strong $ = More Imports and Fewer Exports = (AD L)
Weak $ = Fewer Imports and More Exports = (AD R)

Relative Income
Strong Foreign Economies = More Exports = (AD R)
Weak Foreign Economies = Less Exports = (AD L)
AD reflects an inverse relationship between PL and GDPR
Change in PL creates real-balance, interest-rate, and foreign purchase effects that explain AD’s downward slope
Change in C, IG, G, and/or XN cause change in GDPR because they Δ AD.
Increase in AD = AD shift R
Decrease in AD = AD shift L
Summary
The level of Real GDP (GDPR) that firms will produce at each Price Level (PL)
Long-Run v. Short-Run
Period of time where input prices are completely flexible and adjust to changes in the price-level
In the long-run, the level of Real GDP supplied is independent of the price-level
Period of time where input prices are sticky and do not adjust to changes in the price-level
In the short-run, the level of Real GDP supplied is directly related to the price level
Long-Run Aggregate Supply (LRAS)
The Long-Run Aggregate Supply or LRAS marks the level of full employment in the economy (analogous to PPC)
Short-Run Aggregate Supply (SRAS)
An increase in SRAS is seen as a shift to the right.

A decrease in SRAS is seen as a shift to the left.

The key to understanding shifts in SRAS is per unit cost of production

Per-unit production cost = total input cost/total output
Determinants of SRAS
(all of the following affect unit production cost)
Input Prices
Productivity
Legal-Institutional Environment
The Great Depression
unemployment
failed banks
fear
hunger
Why have a macroeconomic model?
to explain the business cycle
confusion
menu costs
sticky price
fixed wages
Why is SRAS upsloping?
What would allow us to produce more output at any given price level? The answer is: a change in our resource base, or a change in technology.
LRAS
SRAS
RGDP
PL
Full employment= all resources are employed.

If we go faster- we run the risk of inflation

And if we go slower, then we’ve got unemployment
3 phase model
Keynesian
Classical Model
Intermediate
low output
full employment
Pl and output
PL
RGDP
In the LR, prices are flexible
Therefore Changes in PL do not change output
Consumer expectations
+ expectations = + spending (AD shifts R)
Household indebtedness
-debt = + spending (AD shifts R)
+ debt = - spending (AD shifts L)

Taxes
- taxes = + spending (AD shifts R)
+ taxes = - spending (AD shifts L)
- expectations = - spending (AD shifts L)
Expected Returns
Higher Expected Returns = More Investment (AD R)
Lower Expected Returns = Less Investment (AD L)
Expected Returns are influenced by
Expectations of future profitability
Technology
Degree of Excess Capacity (Existing Stock of Capital)
Business Taxes
Full transcript