Aggregate demand: Schedule indicating spending plans of agents at alternative price levels.

Pri

ce le

vel

Y0

AD1

AD2

Any factor that wouldshift the AE schedulewill shift AD as well

Pri

ce le

vel

Y0

AD1

AD2

AD1 to AD2 due to:

•Increase in income

•Increase in wealth

•Increase in consumer or business confidence

•Population growth

•Lower taxes

Pri

ce le

vel

Y0

AD1

to due to

The wealth effect.

The interest rate effect

The international trade effect.

The interest rate effect is poorly

explained by Boyes& Melvin on pp. 207-208

Aggregate supply is the schedule indicating the quantity to total output supplied at alternative price levels

Pri

ce le

vel

Y0

AS1 AS2 AS1 AS2 due to:

•Rising input prices (wages, intermediate goods, raw materials)

•Decreased productivity

Productivity () means the average output of a worker

per year, or alternatively: = Y/N

where N is total employment.

depends onthe efficiency with

which labor is employedin the production of

goods & services

Let denote average annual compensation of employees (including benefits). Thus unit labor cost (UCL) is defined as:

ULC = /

Notice that compensationcan rise with no effect on ULC,

so long as productivitykeeps pace

Pri

ce le

vel

YY1

AS1AS2

An increasein ULC atevery level

of Y will shiftAS to the left

0

P1

P2

Pri

ce le

vel

Y0

AS

AD1

AD2

2

1

Many economiststhink this accurately

describes the U.S.situation in 1966-68

Notice that both Y and P increase

Y*

LRAS

AD1

AD2P1

P2

0Y

Pri

ce le

vel

With the economyat full-employment,

a change in AD affects prices --but not output,

real income, or employment

Pri

ce le

vel

Y0

AS1

AD

AS2

Y2Y1

P1

P2

Cost-push isa drag sinceY decreases

and P increases

•Grain failures

•Anchovies

•Oil shocks

•Wage and salary pressures

Stagflation is thesimultaneous

presence of highinflation and

unemployment

Date Price ($)Jan. 1972 1.79Dec. 1973 4.68Jan. 1974 10.84

April 1979 14.55June 1979 18.00

Nov 1979 24.00

Aug. 1980 30.00Oct. 1981 34.00

Source: The Petroleum Economist

I’d call that a shock,wouldn’t you? The story

of Joseph (see Old Testament)suggests buffer stocks

as the remedy forsupply-shock

inflation

Price of One Barrel of 340 crude oil

0

20

40

60

80

100

120

1982=100

Productivity and Costs, 1974-83

Productivity 93.2 95.1 97.9 99.7 101 99.5 99.2 100 102

Compensation 49.9 54.8 59.7 64.5 70.1 77 85.1 100 104

Unit Labor Cost 53.5 57.6 61 64.7 69.7 77.4 85.6 100 101

74 75 76 77 78 79 80 82 83

Source: Economic Report of the President