Econ 202: Chapter 9
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Transcript of Econ 202: Chapter 9
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Chapter 09:Aggregate Demand
Copyright © 2013 by The McGraw-Hill Companies, Inc !ll rights reser"e# McGraw-Hill$Irwin
13e
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AD’s Role in a Recession and
Recovery• In the Great Recession, spending
decreased across the board and
layofs occurred in many industries. – AD declined. It shited let away rom
ullemployment GD! as the country ellinto recession.
– "o escape rom recession, AD mustincrease. "he AD curve must shit to theright toward ullemployment GD!.
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AD’s Role in a Recession and
Recovery• In this chapter we e#plore what is behind
the AD curve. $peci%cally, what causes
AD to shit& – 'hat are the components o aggregate
demand&
– 'hat determines the level o spending or
each component& – 'ill there be enough demand to maintain
ull employment&
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(earning )b*ectives
• ++-. now what the ma*or componentso aggregate demand are.
• ++/. now what the consumptionunction tells us.
• ++0. now the determinants oinvestment spending.
• ++1. now how and why AD shitsoccur.
• ++2. now how and when macro ailureoccurs.
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3acro 45uilibrium
• In the macro model, AD and A$ intersect. – "his is macro equilibrium.
• Macro equilibrium: the combination oprice level and real output that iscompatible with both AD and A$. – "he rate o output e5uals the rate o
spending. – I there are no disturbances, the economy
gravitates to macro e5uilibrium.
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Ad*usting 3acro 45uilibrium
• 3acro e5uilibrium isoccurring where AD- intersects A$. "his is
insu6cient to ensure ullemployment. – QE 7QF.
• "he economy is producingbelow capacity, so thereis high unemployment.
• 8ow can AD shit right toAD/ and ull employment&
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9omponents o AD
• "he our components o AD are
– 9onsumption :C;.
– Investment :I;. – Government spending :G;.
–
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9onsumption :C;• Consumption (C): e#penditure by
consumers on %nal goods and services.
– Accounts or over twothirds o total spending.
– 9onsumers tend to spend most o theirdisposable income : D; = that is, income
remaining ater ta#es. "hey save the rest.
– !a"ing (S): Disposable income not spent as
consumption :9;.
Disposable income = Consumption + SavingY D = C + S
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3arginal !ropensity to9onsume
:3!9;• M#C: the raction o each additional
:marginal; dollar o disposable
income spent on consumption.
MPC = Change in consumption = ΔC
Change in disposable income ΔY
D
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AD $hit >actors
• A change in consumption :C; causes AD to shit. – "hus AD will shit in response to changes in
• Income.
• 4#pectations :consumer con%dence;.• 'ealth.
• 9redit conditions.
• "a# policy.
• In /++?/++, home e5uity ell :wealth decrease;and consumer con%dence ell. AD shited let,resulting in the Great Recession.
• $hits in AD can be a cause o macro instability.
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Investment
• $n"estment: e#penditures on newplants, e5uipment, and structures, pluschanges in inventories.
– Includes %#ed investment and inventoryinvestment. – >avorable e#pectations o uture sales are
necessary or investment spending. – Investment spending is inversely related to
interest rates, ceteris paribus. – "echnological advances stimulate
investment spending.
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"he Investment >unction
• Investment spendingis inversely related tothe interest rate.
• I e#pectations outure sales improve,the investmentunction shits right, aswill AD. @ice versa
applies.• Investment spending
is the most volatilecategory o spending.
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Government $pending
• ecause o balanced budget re5uirements,state and local spending will decrease whenconsumption and investment spending
decrease. "his contributes to instability.• ecause o de%cit spending, ederal spending
can be increased to counter spendingdecreases in the other components.
– "his is the basis o eynesian demandside policy.
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3acro >ailure
!anel :a; is where we want to be.!anel :b; is when macro e5uilibrium occurs with high unemployment:too little AD;.
!anel :c; is when macro e5uilibrium occurs with too much inCation :toomuch AD;.
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3acro >ailure
• "wo concerns about macro e5uilibrium – 3acro e5uilibrium might not give us ull
employment or price stability.
– 4ven when macro e5uilibrium is perectlypositioned, it might not last.
• 45uilibrium with cyclical unemployment :toolittle AD; occurs with a recessionary GD! gap.
• 45uilibrium with demandpull inCation :toomuch AD; occurs with an inCationary GD!gap.
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Recessionary GD! Gap
• %ecessionar& 'D#gap: the amount bywhich e5uilibriumGD! alls short o ull
employment GD!. – At #, too much would
be produced. "here areunsold inventories. 'ecut bacE production
and lay of worEers. – 45uilibrium occurs at
# andQE, which is less
than QF.
P r i c e
l e v e l
Real GDPQF
P*
AS
AD
QE
P2
Recessionary
GDP gap
Q2
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InCationary GD! Gap
• $n*ationar& 'D#gap: the amount bywhich e5uilibrium GD!e#ceeds ull
employment GD!. – At #, not enoughwould be produced.'ith inventoriesdepleted, we begin tostrain capacity and
prices rise. – 45uilibrium occurs at #+
and QE, which is greaterthan QF.
P r i c e
l e v e l
Real GDP
QF
P*
AS AD
QE
P3
InflationaryGDP gap
Q3
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"he 4conomy "omorrow
• Anticipating AD shits.
• 8ow can policy maEers tell what is
going to happen ne#t& – "he Inde# o (eading Indicators is a list o
-+ gauges that are supposed to indicatein what direction the economy is moving.
– Included are e5uipment orders, consumercon%dence, and building permits.
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"he 4conomy "omorrow
• 8ow is the inde# used&
– 'hen the inde# rises it is viewed as good newsor the economy :and vice versa;.
– 9hanges in the inde# are used to orecastchanges in GD! and turns in the business cycle.
• "he purpose o this inde# is to help predict
movements in GD! and the business cyclein the economy tomorrow.
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Inde# o (eading Indicators$ndicator E,pected $mpact
-. Average worEweeE 8ours worEed per weeE typicallyincrease when greater output andsales are e#pected.
/. Bnemployment claims Initial claims or unemploymentbene%ts reCect changes in industry
layofs. 0.
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Revisiting the (earning
)b*ectives• ++-. now what the ma*or
components o aggregate demand are. – "he components are consumption :C;, investment :I;,
government spending :G;, and net e#ports : X - M;.
– C is inCuenced by nonincome actors and by currentincome, as indicated in the consumption unction.
– I depends on interest rates, e#pectations o uture sales,and innovation.
– G depends on budgetary restraints and borrowing.
– X . M depends on marEet actors in the buying nation.
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Revisiting the (earning
)b*ectives• ++/. now what the consumption
unction tells us.
– It tells us that consumption spending :9; hastwo components, one o which is autonomousand the other is incomedependent.
– "he upward slope o the consumption unction
is the marginal propensity to consume :3!9;.
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Revisiting the (earning
)b*ectives• ++0. now the determinants o
investment spending.
– Investment spending depends on interestrates, e#pectations o uture sales, andinnovation.
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Revisiting the (earning
)b*ectives• ++1. now how and why AD shits
occur.
– AD shits right i any o the ourcomponents increase
• C increases.
• I increases.
• G increases.• X . M increases.
– @ice versa applies or AD to shit let.
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Revisiting the (earning
)b*ectives• ++2. now how and when macro
ailure occurs. –
3acro ailure occurs when the economyails to achieve ull employment and pricestability.
– 3acro ailure can be caused by• "oo little aggregate demand :causing cyclical
unemployment;.
• "oo much aggregate demand :causingdemandpull inCation;.