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Keywords: P lanned & Actua l Investment
Planned investment (Ip) is the amount of investment firms plan to
undertake during a year = Total business expenditures on plants and
equipments + planned production of inventories (goods that firms
are planning to keep as inventories for the future).
Actual investment (I) is the amount of investment actually
undertaken during a year = planned investment + unplanned changes
in inventories = (Ip) + unplanned changes in inventories .
(I) (Ip) = unplanned changes in inventories can be either positive
(unintended inventory accumulation: actual inventories > planned
inventoriesthere was a lack of demand) or negative (unintended
inventory decumulation: actual inventories < planned inventories
there was an excess of demandyou had to sell goods that you had
been planning to keep as inventories for the future).
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A g g r e g a t e D e m a n d ( A D ) - D e f i n i t i o n
In macroeconomics, the focus is on the demand and supply of all goods and
services produced by an economy. Accordingly, the demand for all individual
goods and services is combined and referred to as aggregate demand. AD is
the total amount of goods and services demanded in the economy at a given
overall price level and in a given time period. AD correspond to the total value
of REAL GDP that all sectors of the economy are willing to purchase at a given
overall price level and in a given time period.
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A g g r e g a t e D e m a n d ( c o n )
AD = C + Iplanned+ G + (EXIM)
Recall: GDP (Y), by the expenditure
approach is:
Y = C + I + G + (EXIM)
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A g g r e g a t e D e m a n d ( c o n )
If firms produce goods that NEITHER THE FIRM NOR THE
CUSTOMERS WERE DEMANDING, those goods are counted
in GDP, as unintended inventory accumulation, but they are
not part of aggregate demand, because, clearly, NOBODY
desired them.
The difference between AD and GDP = unintended
inventory accumulation.
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Aggregate Demand - Components
Aggregate demand is composed of the sum of aggregate expenditures:
AD= Expenditures = C + Iplanned+ G +(X - M)
Where:
C = Consumers' expenditures on goods and services.
Iplanned= The amount of investment firms plan to undertake during a year.
G = Governments expenditures on publicly provided goods and services.
X = Exports of goods and services.
M = Imports of goods and services.
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Aggregate Demand Curve
Aggregate demand is represented
by the aggregate-demand
curve, which represents the
quantity of goods and services
that will be demanded
(purchased) at different price
levels. This is the demand for
the gross domestic product
(GDP) at different price levels.
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1) The Real Balance Effect
A higher aggregate price level (higher inflation) reduces thepurchasing power of householdsand companies wealththeywill feel poorertheir spending will .
2) The Interest Rate EffectA higher aggregate price level (higher inflation) Nominal
interest rate (nominal interest rate = real interest rate + inflationrate )savingsspending .
3) The Foreign Purchases Effect
If prices rise in the homeland, exports decrease and importsincrease, so Xnetdecreases.
Three Reasons why the AD Curve Slopes Down
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When a change in the price level
causes equilibrium GDP to change,
we move along the AD curve.
Whenever anything other than the
price level causes equilibrium GDP to
change, the AD curve itself shifts.
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S h i f t F a c t o r s o f t h e A D C u r v e
Shifts in the aggregate demand curve are not caused by changes inthe price level. Instead, they might be caused by ANY changes:
1) In the demand for consumption goods and services (C).
2) In investment spending (I).
3) In the government's demand for goods and services (G).
4) In the demand for net exports (EXIM).
5) In fiscal policy [Tax and/or government spendingAD].
6) In monetary policy [Federal Reserve money supply interest rates spendingAD].
7) In consumer confidence or expectations.
8) In consumer wealth.
9) In the stock of physical capital (factors of production, such as
machinery, buildings, or computers..).
S h i f f h A D C ( )
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S h i f t s o f t h e A D C u r v e ( c o m )
In general, any expansionary policy
shifts the aggregate demand curve to
the right while any contractionarypolicy shifts the aggregate demand
curve to the left.
A shift to the right of the aggregate
demand curve. from AD to AD, means
that at the same price levels the
quantity demanded of real GDP
has increased.
A shift to the left of the aggregate
demand curve, from AD to AD, means
that at the same price levels the
quantity demanded of real GDP
has decreased.
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Aggregate Supply (AS)
Aggregate Supplyis the total supply of goods and services that firms in
a national economy plan on selling during a specific time period. It is
the total amount of goods and services that firms are willing to sell at
a given price level in an economy. Aggregate supply is represented
by the aggregate- supply curve, which represents the quantity of
real GDP that is supplied by the economy at different price levels.
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The Short Run Aggregate Supply Curve
Classical economists believe that in the
short run the aggregate supply curve is
upward sloping. In the short run an
increase in aggregate demand may lead
to an increase in output, but there will
also be an increase in the price level.
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The Long Run Aggregate Supply Curve
Classical economists believe that in the long run the
level of real production (GDP) is maintained
regardless of the price level, which creates a vertical,
or perfectly elastic, aggregate supply curve. This
relation results due to flexible prices, which ensure
that resources markets maintain equilibrium balance
at full employment (which corresponds to the natural
unemployment rate) . Should the price level rise or fall,
wages and resource prices adjust to ensure that
quantity demanded equals quantity supplied in
resource markets.
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The Keynesian Aggregate Supply Curve
John Maynard Keynes argued that prices and wages were
sticky, in particular they were inflexible downward due to the
existence of unions and contracts between employers and
employees. He argued that in a world of excess capacity, an increase
in aggregate demand will not impact prices (as the classical
economists thought) but will instead impact real GDP.
The assumptions of the Keynesian model are the same as the
classical model except for two important differences: prices and
wages are sticky, and excess capacity exists in the economy.
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The Keynesian Aggregate Supply Curve (con)
Within the Keynesian framework,
the aggregate supply (AS) curve
is sketched horizontally. This is
done because prices are sticky
in the short run, represented by
the flat line (prices dont
change). Because this onlyoccurs in the very short run, we
label this the short run
aggregate supply curve (SRAS1).
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The Keynesian Aggregate Supply Curve (con)
New Keynesians realized thatprices and wages were notperfectly sticky, even in theshort run. Because of thisthey developed a new SRAS
curve which was upwardsloping. This allowed forsome price and wagestickiness, but also allowed
for some flexibility. Thisupward sloping SRAS2 supplycurve has become thestandard SRAS curve used ineconomic analysis.
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The Keynesian Aggregate Supply Curve (con)
We may also see charts thatshow two SRAS curves, onehorizontal, and one upwardsloping. Generally thehorizontal curve shows thevery short run, and the upwardsloping shows the short tomedium run aggregate supplycurve. In the long run, we endup back with the classicalmodel (LRAS), so the threedifferent aggregate supplycurves show us how prices andreal GDP will change overshort, medium, and long timeframes.
T h A D A S M d l
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T h e A D A S M o d e lThe ADAS or aggregate demand
aggregate supply model is a
macroeconomic model that
explains price level and output
(GDP) through the relationship of
aggregate demand and aggregate
supply. It is based on the theory of
John Maynard Keynes presented in
his work The General Theory of
Employment, Interest, and Money.
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