Unit 3-3:Aggregate Demand and Supply and Fiscal Policy

1

Shifters of Aggregate Demand

Change in Consumer Spending

Change in Investment Spending

Change in Government Spending

Net EXport Spending

AD = C + I + G + X

Shifters of Aggregate SupplyAS = R + A + P

Change in Resource Prices

Change in Actions of the Government

Change in Productivity

2

Putting AD and AS together to getEquilibrium Price Level and Output

3

Price Level

4

AD

AS

GDPRQY

PLe

LRAS

Use the AD and AS model to show an economy at full employment output

Price Level

5

AD

AS

#1. Assume there is an increase in consumer spending. What happens to PL and output in the

short- run?

GDPR

LRAS

QY

AD1

PLe

PL1

Q1

PL and Q will Increase

Practice

6

AD or AS ShifterIncrease or Decrease

1

2

3

4

5

6

7

8

9

10

Practice1. An increase in consumer spending2. The impact on net exports when a trading partner has a recession3. A significant increase in the price of oil that affects the resource costs of businesses4. Government increases spending but not taxes5. Increase in wages that businesses pay workers 6. Effect on businesses when they expect inflation7. Effect on investment when interest rates decrease 8. An increase in productivity9. The impact on next exports when the country’s currency depreciates10. Government increases corporate taxes

7

Ca

pit

al G

oo

ds

Consumer Goods

The economy can only be in one of three places at any time

8

Full Employment5% Unemployment

Max Capacity0% Unemployment

Time

Real GDP

Real GDP

Recessionary GapFull EmploymentInflationary Gap

Price Level

9

AD

AS

Example: Assume the government increases spending. What happens to PL and Output?

GDPR

LRAS

QY

AD1

PLe

PL1

Q1

PL and Q will Increase

Price Level

10

AS

Inflationary Gap

GDPR

LRAS

QY

AD1

PL1

Q1

Output is high and unemployment is less than NRU

Actual GDP above potential

GDP

Price Level

11

AD

AS

GDPRQY

PLe

PL1

Q1

LRAS

AD1

Example: Assume consumer spending falls. What happens to PL and Output?

PL and Q will decrease

Price Level

12

AS

GDPRQY

PL1

Q1

LRAS

AD1

Actual GDP below potential

GDP

Recessionary Gap

Output low and unemployment is more than NRU

Price Level

13

AD

AS

GDPRQY

PLe

PL1

Q1

LRAS AS1

StagflationStagnate Economy

+ Inflation

Example: If there is a negative “supply shock” of oil. What happens to PL and Output?

Still considered recessionary gap

What Happens In the Long-Run?

14

15

AD

AS

If consumer spending increases, what will happen in the short-run and in the long-run?

GDPRQY

AD1

PLe

PL1

Q1

LRAS

In the long-run, wages and costs increase

AS1

PL2

Time

Real GDP

PriceLevel

Real GDP

16

If consumer spending increases, what will happen in the short-run and in the long-run?

GDPRQY

AD1

LRAS

In the long-run, wages and costs increase

AS1

PLe

Time

Real GDP

PriceLevel

Real GDP

17

AD

AS

If consumer spending decreases, what will happen in the short-run and in the long-run?

GDPRQY

AD2

PLe

PL1

Q1

LRAS

In the long-run, wages & costs eventually decrease

AS2

PL2

Time

Real GDP

PriceLevel

Real GDP

18

AD

AS

If investment increases, what happens in the short-run and long-run?

GDPRQY

AD1

PLe

PL1

Q1

LRAS

Capital Stock- Machinery and tools purchased by businesses that increase their output

AS1

PriceLevel

Ca

pit

al G

oo

ds

Consumer Goods

The PPC shifts outward since producers can make more

LRAS1

QY1

19GDPR

AD1

PLe

An increase in consumption or government spending doesn’t cause economic growth.

Only Investment causes growth since firms increase their capital stock

AS1

PriceLevel

Ca

pit

al G

oo

ds

Consumer Goods

LRAS1

QY1