Ch. 11: Aggregate Supply and Demand Derive AS/AD model Understand consequences of change in AS/AD...
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Transcript of Ch. 11: Aggregate Supply and Demand Derive AS/AD model Understand consequences of change in AS/AD...
Ch. 11: Aggregate Supply and Demand
Derive AS/AD model
Understand consequences of change in AS/AD
• Short run vs Long run• Effects on economic growth, prices, unemployment.
Different schools of thought in macroeconomics
Macroeconomic Long Run and Short Run
The Macroeconomic LRa time frame that is sufficiently long for the real wage rate
to have adjusted to achieve full employment: Real GDP = potential GDP. Unemployment =natural unemployment rate. Price level determined by quantity of money. Inflation rate =money growth rate minus the real GDP growth rate.
The Macroeconomic SRa period during which some money prices are sticky so
Real GDP might be below, above, or at potential GDP. The unemployment rate might be above, below, or at the natural
unemployment rate
Aggregate Supply
The quantity of real GDP supplied is the total quantity that firms plan to produce during a given period. It depends on
The quantity of the labor employed The quantity of physical and human capital State of technology
Two time frames associated with different states of the labor market:
Long-run aggregate supply Short-run aggregate supply
Aggregate Supply
Long-Run Aggregate Supplythe relationship between the quantity of real GDP supplied and the price level when real GDP equals potential GDP.
Potential GDP is determined by
•Production function•Labor market•Independent of price level
LR aggregate supply curve (LAS) is vertical at potential GDP.
Determinants of LASEffect of each on LASIncrease in labor supply
• immigration• taxes on employees• transfers (UI, SS)• population growth• retirement
Increase in labor demand
• worker productivity (also affects PF)• taxes on employer payroll
Shifts in Production Function
• capital/technology• human capital
Aggregate Supply
Short-Run Aggregate Supplythe relationship between real GDP supplied and the price level when the money wage rate, the prices of other resources, and potential GDP remain constant.
A rise in the price level with no change in the money wage rate and other factor prices increases the quantity of real GDP supplied.
• as P rises, real wage declines, firms want to hire more employees (movement along labor demand curve)
The short-run aggregate supply curve (SAS) is upward sloping.
Aggregate Supply
Along the SAS curve, real GDP supplied might be above potential GDP…
or below potential GDP.
Aggregate Supply
Changes in Aggregate SupplyWhen potential GDP increases, both the LAS and SAS curves shift rightward.
Potential GDP changes, for three reasons:
The full-employment quantity of labor changes
The quantity of capital (physical or human) changes
Technology advances
Aggregate Supply
An increase in potential GDP shifts the LAS curve and the SAS curve shifts along with the LAS curve.
Aggregate Supply
A rise in the money wage rate
Decreases short-run aggregate supply
and shifts the SAS curve leftward.
Has no effect on long-run aggregate
supply.
Aggregate Demand
AD is the total amount of final goods and services produced in the United States that people, businesses, governments, and foreigners plan to buy.
AD= C + I + G + X – M.
AD depends on
The price level Expectations about future Changes in wealth Fiscal policy and monetary policy The world economy
Aggregate Demand
The Aggregate Demand Curveplots the quantity of real GDP demanded against P.
slopes downward for 2 reasons:
Wealth effect Substitution effects
Aggregate Demand
Wealth Effect
• P increases real wealth decreases C decreases
AD decreases
Substitution Effects
1. Intertemporal• P increases interest rate increases C & I decrease
AD decreases
2. International• P increases imports increase, exports decrease AD decreases
Shifts in Aggregate Demand
Expectations about future
• Increases in expected future income increases C today increases AD.
• Increase in expected future inflation buying goods cheaper today increases AD.
• Increase in expected future profits investment
increases AD.
Shifts in Aggregate Demand
Fiscal Policysetting and changing taxes, transfer payments, and purchasing goods and services.
An income tax cut or increase in transfers increases disposable income (income-taxes+ transfers) increases C increases AD
An increase in government spending increases G increases AD
Shifts in Aggregate Demand
Monetary policy
changes in interest rates and the quantity of money in the economy.
An increase in the money supply reduces interest rates and increases aggregate demand.
Shifts in Aggregate Demand
The World EconomyA weaker dollar
exports increase; imports decrease AD rises
An increase in foreign income I increases the demand for U.S. exports increases aggregate demand.
Macroeconomic Equilibrium
SR Equilibrium:SAS=AD
GDP can be above, below, or at potential GDP
LR equilibriumLAS=SAS=AD
Macroeconomic Equilibrium
Graphical illustration of SR equilibria with
1.GDP>potential GDP (inflationary gap)
2. GDP<potential GDP (recessionary gap)
3. GDP=potential GDP (LR equilibrium)
Transition from GDP>potential GDP to LR equilibriumemployment > equil. employment
(unemployment < natural rate)real wage < equil. real wageupward pressure on real waqesSAS shifts left until GDP=potential GDP
Transition from GDP<potential GDP to LR equilibriumemployment < equil. employment
(unemployment > natural rate)real wage > equil. real wagedownward pressure on real waqesSAS shifts left until GDP=potential GDP
SR/LR effect of changes in AD
Effect of Increase in AD on real wage, prices, real GDP unemployment and employment.
SR/LR effect of changes in AD
Effect of decrease in AD on real wage, prices, real GDP unemployment and employment.
Macroeconomic Schools of Thought
Three broad schools of thought:
Classical
believes the economy is self-regulating and always at full employment.
Keynesian
Due to sticky wages/prices, the economy would rarely operate at full employment and that to achieve and maintain full employment, active help from fiscal policy and monetary policy is required
Monetarist
economy is self-regulating and that it will normally operate at full employment, provided that monetary policy is not erratic and that the pace of money growth is kept steady