Aggregate Demand and Aggregate Supply

29

McGraw-Hill/Irwin Copyright © 2012 by The McGraw-Hill Companies, Inc. All rights reserved.

Aggregate Demand

• Real GDP desired at each price level• Inverse relationship

• Real balances effect

• Interest effect

• Foreign purchases effect

LO1 29-2

Aggregate Demand

Real domestic output, GDP

Pri

ce l

evel

AD

LO1

0

29-3

Changes in Aggregate Demand

• Determinants of aggregate demand

• Shift factors affecting C, I, G, Xn

• 2 components involved

• Change in one of the determinants

• Multiplier effect

LO1 29-4

Changes in Aggregate Demand

Real domestic output, GDP

Pri

ce l

evel

AD1AD3

AD2

LO1

0

29-5

Consumer Spending

• Consumer wealth• Household borrowing• Consumer expectations• Personal taxes

LO1 29-6

Investment Spending

• Real interest rates• Expected returns

• Expectations about future business conditions

• Technology

• Degree of excess capacity

• Business taxes

LO1 29-7

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

LO1 29-8

Net Export Spending

• National income abroad• Exchange rates

• Dollar depreciation

• Dollar appreciation

LO1 29-9

Aggregate Supply

• Total real output produced at each price level

• Relationship depends on time horizon

• Immediate short run

• Short run

• Long run

LO2 29-10

AS: Immediate Short Run

Real domestic output, GDP

Pri

ce l

evel

ASISR

Qf

Immediate-short-runaggregate supply

P1

0

LO2 29-11

Aggregate Supply: Short Run

Real domestic output, GDP

Pri

ce l

evel

0 Qf

AS

Aggregate supply(short run)

LO2 29-12

Aggregate Supply: Long Run

Real domestic output, GDP

Pri

ce l

evel

ASLR

Qf0

Long-runaggregatesupply

LO2 29-13

Changes in Aggregate Supply

• Determinants of aggregate supply

• Shift factors• Collectively position the AS curve• Changes raise or lower per-unit

production costs

LO2 29-14

Changes in Aggregate Supply

Real domestic output, GDP

Pri

ce l

evel

AS1

AS3

AS2

0

LO2 29-15

Input Prices

• Domestic resource prices

• Labor

• Capital

• Land• Prices of imported resources

• Imported oil

• Exchange rates

LO2 29-16

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

29-17

Legal-Institutional Environment

• Legal changes alter per-unit costs of output

• Taxes and subsidies

• Extent of government regulation

LO2 29-18

Equilibrium

Real domestic output, GDP(billions of dollars)

Pri

ce le

vel (

ind

ex n

um

ber

s)

100

92

502 510 514

ab

AD

ASReal Output Demanded(Billions)

Price Level(Index Number)

Real OutputSupplied(Billions)

$506 108 $513

508 104 512

510 100 510

512 96 507

514 92 502

0

LO3 29-19

AD Increases: Demand-Pull Inflation

Real domestic output, GDP

Pri

ce le

vel

AD1

AS

P1

P2

Q2Q1Qf

AD2

0

LO4 29-20

Decreases in AD: Recession

Real domestic output, GDP

Pri

ce le

vel

AD1

AS

P1

P2

Q1 Q2 Qf

AD2

c

ab

0

LO4 29-21

Decreases in AD: Recession

• Prices are downwardly inflexible

• Fear of price wars

• Menu costs

• Wage contracts

• Efficiency wages

• Minimum wage law

LO4 29-22

Decreases in AS: Cost-Push Inflation

Real domestic output, GDP

Pri

ce le

vel

AD

AS1

P1

P2

Q1 Qf

AS2

a

b

0

LO4 29-23

Increases in AS: Full-Employment

Real domestic output, GDP

Pri

ce le

vel

AD1

AS2

P1

P2

Q2Q1

AS1

b

AD2

c

P3

Q3

a

0

LO4 29-24

Impact of Oil Prices Diminished?

• 1970’s

• Reduced AS and negative GDP gap

• Cost-push inflation

• Rising unemployment• 2000’s

• Core inflation steady

• Use 50% less oil and gas today

• Federal Reserve more vigilant

29-25