1 Macroeconomics: Modeling the Behavior of Aggregate Variables
Principles of Macroeconomics...Principles of Macroeconomics Module 3.1 Aggregate Demand 120. AD-AS...
Transcript of Principles of Macroeconomics...Principles of Macroeconomics Module 3.1 Aggregate Demand 120. AD-AS...
PrinciplesofMacroeconomicsModule3.1
AggregateDemand
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AD-ASModelSnapshotoftheaggregateeconomy• Whyandhowaneconomyexperiencesgrowthinlongrun andfluctuationsintheshortrun
• Whyandhowthepricelevelchanges
• Howoutputchangesasaresultofshortrunshocks
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AD-ASModel
• Aggregatedemand(AD):allgoodsandservicesallhouseholds,firms,andgovernmentwantstobuyateachpricepoint
• LongRunAggregateSupply(SRAS):allgoodsandservicessuppliedbyfirmsateachpricepointinthelongrun
• ShortRunAggregateSupply(SRAS):allgoodsandservicessuppliedbyfirmsateachpricepointintheshortrun
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AggregateDemand
Y=C+I+G+NXTherelationshipbetweenPriceandADisdrivenbytheinfluenceofPrice
onC,I,G,andNX
LowerP=HigherC,I,NXHigherP=LowerC,I,NX
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DeterminingAggregateDemand
WealthEffect:(C)• Atlowerpricelevel– valueofmoneyishigher
• Consumerscanbuymorewitheach$andthereforearecompelledtospendmore
• Atlowerpricelevels– higherlevelofConsumptionspending
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DeterminingAggregateDemandInterestRateEffect:(I)
• Atlowerpricelevel– householdsreducemoneyholdingsbylendingsomeout,leadingtoafallininterestrates
• Interestratesfallandfirmsareencouragedtoborrowandinvest
• Atlowerpricelevels– higherlevelofInvestmentspending
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DeterminingAggregateDemandExchangeRateEffect:(NX)
• Basedontheinterestrateeffect:lowerpricelevelscorrespondtolowerinterestrates(domestically)
• Withlowerinterestrates,domesticandforeigninvestorswillseekhigherreturnsabroad
• Netcapitaloutflow:↑demandforFX↓demandforUSD
• USDdepreciates-- USexportsbecomecheaper,importsaremoreexpensive
• Atlowerpricelevels– higherlevelofNetExports126
ShiftsinAggregateDemandADCurvewillshiftifanyofthecomponentsofADchange• ChangeinC:Familiesacrosstheeconomyareincreasingspendingongoodsandservices
• ChangeinI:Firms,overall,arebuyingnewcapitalgoodsandmachines,expandingtheirbusinessfacilities,ect.
• ChangeinG:Governmentisspendingmore,buildingnewinfrastructure,improvingtheeducationsystem,buyingnewweapons
• ChangeinNX:ExportsfromtheUStoothercountriesincrease127
KeyTakeaways• AD-ASmodelexplainshortrunfluctuationsintheeconomyaswellaslongruntrends
• Therearemanyfactorsthatcaninfluencetheeconomyasawholeandthismodelwillhelpexplainhowandwhy
• AggregateDemand:summarizesallofthespendingbehaviorongoodsandservicebyallhouseholds(C),firms(I),government(G)andforeigntransactions(NX)intheeconomy
• ChangesinAD:drivenbyC,I,G,orNX128
PrinciplesofMacroeconomicsModule3.2AggregateSupply
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AD-ASModelSnapshotoftheaggregateeconomy• Why/howexperienceeconomicgrowthinlongrun andfluctuationsintheshortrun
• Why/howpricelevelchanges
• Howmonetaryandfiscalpolicyimpacttheeconomyasawhole
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AD-ASModel
• Aggregatedemand(AD):allgoodsandservicesallhouseholds,firms,andgovernmentwantstobuyateachpricepoint
• LongRunAggregateSupply(SRAS):allgoodsandservicessuppliedbyfirmsateachpricepointinthelongrun
• ShortRunAggregateSupply(SRAS):allgoodsandservicessuppliedbyfirmsateachpricepointintheshortrun
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LongRunvs.ShortRun
• Inthelongrunà nominalvariablesandrealvariablesareseparate• Changesinnominalvariableswillhavenoimpactonrealvariables• ClassicalDichotomy• ChangesinPriceLevel,Inflation,MoneySupplywillnotimpactRealGDP
• Intheshortrunà nominalandrealandmorecloselylinked• Classicaldichotomybreaksdown• Nominalfactorssuchaschangingpricelevels,inflation,andmoneysupplywillhavesomeimpactonrealvariablesintheshortrun
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LongRunvs.ShortRun
• Inthelongrunà nominalvariablesandrealvariablesareseparate• Changesinnominalvariableswillhavenoimpactonrealvariables• ClassicalDichotomy• ChangesinPriceLevel,Inflation,MoneySupplywillnotimpactRealGDP
• Intheshortrunà nominalandrealandmorecloselylinked• Classicaldichotomybreaksdown• Nominalfactorssuchaschangingpricelevels,inflation,andmoneysupplywillhavesomeimpactonrealvariablesintheshortrun
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AggregateSupplyinLongRun
InLongRun:nominalvariableshavenoimpactonrealvariable
Supplyisdeterminedbyavailableresourcesandtechnology
NaturalRateofOutput:Rateofoutputachievedwhenproducingwhereunemploymentisatthenaturalrate
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AggregateSupplyinLongRunInLongRun:nominalvariableshavenoimpactonrealvariable
Supplyisdeterminedbyavailableresourcesandtechnology
NaturalRateofOutput:Rateofoutputachievedwhenproducingwhereunemploymentisatthenaturalrate
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ShiftsinLRAS
ShiftsinLRASwillcomeONLYfrompermanent changes in• availableresources• availableproductiontechnology
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LRAS.2
INCREASEINLRAS
AggregateSupplyintheShortRun
SRASupwardslopingbecauseof:• Stickywages• Stickyprices
Itisthereasonwhywehaveshortruneconomicfluctuations
Y2Y2 Y1
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UpwardSlopingSRASStickyWages:
• Firmshavewageagreementswithemployees• Ifpricesareunexpectedlylower– cannotdecreasewagetomatch• Instead:producelessintheshortrun(hirelessworkers)andmakelaboradjustmentsinthelongrun
StickyPrices:• Notallfirmscanimmediatelychangetheirpricesinresponsetoeconomicconditions
• Ifpricesareunexpectedlylower– relativepricesarehigher(ifcannotchangeprices)
• Higherrelativeprices– losesalesandcutproductionuntiltheycanchangeprices
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UpwardSlopingSRASStickyWages:
• Firmshavewageagreementswithemployees• Ifpricesareunexpectedlylower– cannotdecreasewagetomatch• Instead:producelessintheshortrun(hirelessworkers)andmakelaboradjustmentsinthelongrun
StickyPrices:• Notallfirmscanimmediatelychangetheirpricesinresponsetoeconomicconditions
• Ifthepricelevelisunexpectedlylower– theirrelativepricesarehigher(ifcannotchangeprices)
• Higherrelativeprices– losesalesandcutproductionuntiltheycanchangeprices
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AggregateSupplyintheShortRun
ShiftsinSRAS:• PermanentChangesinResourcesorTechnology
• TemporaryChangesinResourcesorTechnology
• Adjustmentinexpectationsofinflation
SRAS.1
INCREASEINSRAS
Y1
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KeyTakeaways• Aggregatesupplydiffersinthelongrunandshortrun
• Inthelongrun– realandnominalvariablesareseparate
• Intheshortrun– realandnominalvariablesareintertwined
• ShiftsinLRASaredeterminedonlybypermanentchangesinavailableresourcesandproductiontechnology
• ShiftsinSRASaredeterminedbytemporaryorpermanentchangesinavailableresourcesandproductiontechnologyANDinadjustmentsbetweenexpectedandactualpricelevels
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PrinciplesofMacroeconomicsModule3.3
MacroeconomicEquilibrium
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MacroeconomicEquilibrium
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MacroeconomicEquilibrium
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LongRunEquilibrium
InLongRunEquilibrium:EconomyisoperatingattheNaturalRateofUnemployment
ProducingattheNaturalRateofOutput
EquilibriumPriceLevel
EquilibriumPriceLevel
NaturalRateofOutput
MacroeconomicEquilibrium
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Deviationsfromthelong runequilibrium representshort run
economicfluctuations
ShortRunEconomicFluctuations:OccurwhenthereareshiftsinADorSRAS• Determinepricelevelchangesà Inflationin
shortrun
• Determineshortrunfluctuationsinproduction
• Explainbusinesscycles– recessionsandboomperiodsinoureconomy
FactsaboutEconomicFluctuationsEconomicfluctuationsareirregularandunpredictable
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FactsaboutEconomicFluctuationsMosteconomicvariablesfluctuatetogether
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FactsaboutEconomicFluctuationsAsoutputfalls,unemploymentrises
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LongRunEconomicGrowthTwofactshavebeenobservedabouttheeconomyinthelongrun:(1) Technologicaladvancementisconsistent
andcontinuousthroughouttimeà LRASContinuallyINCREASES
(2) MoneySupplyincreasesovertimeàADContinuallyINCREASES
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P
Y
NRO
.1
NRO
.2
NRO
.3
LRAS.1
LRAS.2
LRAS.3
LongRunEconomicGrowthTwofactshavebeenobservedabouttheeconomyinthelongrun:(1) Technologicaladvancementisconsistent
andcontinuousthroughouttimeà LRASContinuallyINCREASES
(2) MoneySupplyincreasesovertimeàADContinuallyINCREASES
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P
Y
AD.1AD.2
AD.3
LongRunEconomicGrowthTwofactshavebeenobservedabouttheeconomyinthelongrun:(1) Technologicaladvancementisconsistent
andcontinuousthroughouttimeà LRASContinuallyINCREASES
(2) MoneySupplyincreasesovertimeàADContinuallyINCREASES
RESULT:- GROWTHINREALGDP- INFLATION
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P
Y
NRO
.1
NRO
.2
NRO
.3
LRAS.1
LRAS.2
LRAS.3
AD.1AD.2
AD.3
P.1
P.2
P.3
TestYourUnderstanding- 1Peoplebecomemoreconcernedaboutsavingforretirementascompanieseliminatepensionplansandotherfirm-sponsoredretirementsupport• DrawoutanAD-ASgraph• ExplainhowthiswillaffectADorAS• IllustratethechangeontheAD-ASgraph• Whathappensintheshort-run?Whathappensinthelong-run?
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TestYourUnderstanding- 1
1. Whichcurveshiftsandwhy?• ShiftAD– consumptionspending
dropstodayaspeoplesavemoreforretirement
2. Whichdirectiondoesitshift?
3. Illustrateandanalyze
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TestYourUnderstanding- 1
1. Whichcurveshiftsandwhy?• ShiftAD– consumptionspending
dropstodayaspeoplesavemoreforretirement
2. Whichdirectiondoesitshift?• Shiftsinortotheleft• DeclineinCà DeclineinAD
3. IllustrateandanalyzeAD.2
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TestYourUnderstanding- 1
1. Whichcurveshiftsandwhy?• ShiftAD– consumptionspending
dropstodayaspeoplesavemoreforretirement
2. Whichdirectiondoesitshift?• Shiftsinortotheleft• DeclineinCà DeclineinAD
3. Illustrateandanalyze• NewEquilibriuminShortRun:B• PriceLevelislower• Outputislower• NEWSHORTRUNEQUILIBRIUM
AD.2
BPb
Yb
TestYourUnderstanding- 2Considertherecentdropinoilpricesfromover$100/barrelin2014toaround$40bytheendof2015.Whatimpactdoesthishaveontheaggregateeconomy?• DrawoutanAD-ASgraph• ExplainhowthiswillaffectADorAS• IllustratethechangeontheAD-ASgraph• Whathappensintheshort-run?Canthisbeapermanentoutcome?
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TestYourUnderstanding- 2
1. Whichcurveshiftsandwhy?• ShiftSRAS– priceofaninput(oil)
islower• Costofproductionisloweroverall
2. Whichdirectiondoesitshift?
3. Illustrateandanalyze
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TestYourUnderstanding- 2
1. Whichcurveshiftsandwhy?• ShiftSRAS– priceofaninput(oil)
islower• Costofproductionisloweroverall
2. Whichdirectiondoesitshift?• Shiftsoutortotheright• IncreaseinSRAS
3. Illustrateandanalyze
SRAS.2
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TestYourUnderstanding- 2
1. Whichcurveshiftsandwhy?• ShiftAD– consumptionspending
dropstodayaspeoplesavemoreforretirement
2. Whichdirectiondoesitshift?• Shiftsoutortotheright• IncreaseinSRAS
3. Illustrateandanalyze• NewEquilibriuminShortRun:C• PriceLevelislower• Outputishigher• NEWSHORTRUNEQUILIBRIUM
SRAS.2
CPc
Yc
KeyTakeaways• AD-ASmodelhelpsexplainwhatishappeningintheaggregateeconomy
• Itexplainshowaneconomyexperienceslongruneconomicgrowthandinflation
• Itexplainshowweexperiencebusinesscyclesandeconomicfluctuationsintheshortrun
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