Chapter 11 Aggregate Demand & Aggregate Supply

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					                      Homework Chapters 11-12
                                   Chapter 11 - Bonus - Friday
                                    January 27.

                                   Chapter 12 - Bonus –
                                    Wednesday, February 1.

                                   Tentative Test Day Friday,
                                    February 3rd.

                                   Hold on here we go!!!

Key concepts chapters 9 – 12!
                 Homework Chapters 9-10-11-12
                                   Test Day - Next Friday
                                   Approximate number of questions per chapter.

                                   Chapter 9 – 10 Questions
                                        Keynesian Cross, MPC, Savings +
                                         Consumption = DI
                                   Chapter 10 – 10 Questions
                                        Simplified, Tax, and Balanced Budget
                                         Multipliers
                                   Chapter 11 – 25 Questions
                                        AD, AS, LRAS
                                   Chapter 12 – 15 Questions
                                        Fiscal Policy: Expansion, Contraction,
                                         Automatic, & Discretionary



Key concepts chapters 9 – 12!
                                CHAPTER ELEVEN




                      Aggregate Demand
                            And
                      Aggregate Supply
Key concepts chapters 9 – 12!
       Aggregate Demand:
       ...the various amounts of goods and
       services - the amounts of real output -
       that domestic consumers, businesses
       and foreign buyers collectively desire
       to purchase at each possible price level




Key concepts chapters 9 – 12!
     Aggregate Demand:
     ...is downsloping because of:




Key concepts chapters 9 – 12!
     Aggregate Demand:
     ...is downsloping because of:

             1 - Wealth Effect (Real Balances)
         A higher price level reduces the purchasing power of the
         general public’s financial assets.

        Remember the arbitrary and capricious nature of inflation???
        That one was for you Sean!



Key concepts chapters 9 – 12!
     Aggregate Demand:
     ...is downsloping because of:

             1 - Wealth Effect (Real Balances)

             2 - Interest-Rate Effect
       When the supply of money is fixed, as price levels rise interest
       rates increase because as the demand for $ increases the price
       paid for its use also increases.


Key concepts chapters 9 – 12!
     Aggregate Demand:
     ...is downsloping because of:

             1 - Wealth Effect (Real Balances)
             2 - Interest-Rate Effect
             3 - Foreign Purchases Effect
         As prices go up in the U.S, our goods become more expensive,
         Thus reducing the amount of exports and increasing imports.



Key concepts chapters 9 – 12!
Deriving the Aggregate Demand Curve


      Aggregate expenditures
                                              (C a + I g + X n + G) 1 at P 1




        (billions of dollars)
                                     1




                                               Real GDP at
                                0              price level 1
                                     GDP1
            Price level




                                         1’
                                P1

                                0    GDP1
Deriving the Aggregate Demand Curve


      Aggregate expenditures
                                              (C a + I g + X n + G) 1 at P 1




        (billions of dollars)
                                     1




                                               Real GDP at
                                0              price level 1
                                     GDP1


                                               What if
            Price level




                                              prices go
                                         1’      up?
                                P1

                                0    GDP1
Deriving the Aggregate Demand Curve


      Aggregate expenditures
                                                        (C a + I g + X n + G) 1 at P 1




        (billions of dollars)
                                               1        (C a + I g + X n + G) 2 at P 2

                                      2


                                                          A Lower Real
                                0                          GDP Exists
                                     GDP2 GDP1
                                                         at price level 2
            Price level




                                P2
                                          2’

                                                   1’
                                P1

                                0    GDP2 GDP1
Deriving the Aggregate Demand Curve


      Aggregate expenditures
                                                        (C a + I g + X n + G) 1 at P 1




        (billions of dollars)
                                               1        (C a + I g + X n + G) 2 at P 2

                                      2


                                                          A Lower Real
                                0                          GDP Exists
                                     GDP2 GDP1
                                                         at price level 2
                                                         What if
            Price level




                                          2’
                                P2                      prices go
                                P1
                                                   1’   up again?
                                0    GDP2 GDP1
Deriving the Aggregate Demand Curve


      Aggregate expenditures
                                                                (C a + I g + X n + G) 1 at P 1




        (billions of dollars)
                                                       1        (C a + I g + X n + G) 2 at P 2
                                                                (C a + I g + X n + G) 3 at P 3
                                              2

                                     3
                                                                 A Still Lower
                                0                               Real GDP Level
                                         GDP2 GDP1
                                                                Exists at price
                            P3
                                         3’                         level 3
            Price level




                                P2
                                                  2’

                                                           1’
                                P1

                                0        GDP2 GDP1
Deriving the Aggregate Demand Curve


      Aggregate expenditures
                                                                   (C a + I g + X n + G) 1 at P 1




        (billions of dollars)
                                                       1          (C a + I g + X n + G) 2 at P 2
                                                                  (C a + I g + X n + G) 3 at P 3
                                              2

                                     3

                                0
                                         GDP2 GDP1

                            P3
                                         3’
            Price level




                                                            The Aggregate Demand
                                                  2’
                                P2                           Can Be Constructed
                                                           1’
                                P1

                                0        GDP2 GDP1
Deriving the Aggregate Demand Curve


      Aggregate expenditures
                                                                   (C a + I g + X n + G) 1 at P 1




        (billions of dollars)
                                                       1          (C a + I g + X n + G) 2 at P 2
                                                                  (C a + I g + X n + G) 3 at P 3
                                              2

                                     3

                                0
                                         GDP2 GDP1

                            P3
                                         3’
            Price level




                                                            The Aggregate Demand
                                                  2’
                                P2                           Can Be Constructed
                                                           1’
                                P1

                                0        GDP2 GDP1
  CHANGES IN AGGREGATE DEMAND


                               AD Can increase...
Price level




                                              AD1
              0
                  Real domestic output, GDP
  CHANGES IN AGGREGATE DEMAND
Price level




                                                    AD2
                                              AD1
              0
                  Real domestic output, GDP
  CHANGES IN AGGREGATE DEMAND


                               AD Can decrease...
Price level




                                                    AD2
                                              AD1
              0
                  Real domestic output, GDP
  CHANGES IN AGGREGATE DEMAND
Price level




                                                    AD2
                                              AD1
                                       AD3
              0
                  Real domestic output, GDP
        DETERMINANTS OF AGGREGATE DEMAND




Key concepts chapters 9 – 12!
        DETERMINANTS OF AGGREGATE DEMAND
         Change in Consumer Spending




Key concepts chapters 9 – 12!
        DETERMINANTS OF AGGREGATE DEMAND
         Change in Consumer Spending
         • Consumer wealth




Key concepts chapters 9 – 12!
        DETERMINANTS OF AGGREGATE DEMAND
         Change in Consumer Spending
         • Consumer wealth
         • Consumer expectations




Key concepts chapters 9 – 12!
        DETERMINANTS OF AGGREGATE DEMAND
         Change in Consumer Spending
         • Consumer wealth
         • Consumer expectations
         • Consumer indebtedness




Key concepts chapters 9 – 12!
        DETERMINANTS OF AGGREGATE DEMAND
         Change in Consumer Spending
         • Consumer wealth
         • Consumer expectations
         • Consumer indebtedness
         • Taxes




Key concepts chapters 9 – 12!
        DETERMINANTS OF AGGREGATE DEMAND
         Change in Consumer Spending
         • Consumer wealth
         • Consumer expectations
         • Consumer indebtedness
         • Taxes
           Change in Investment Spending




Key concepts chapters 9 – 12!
        DETERMINANTS OF AGGREGATE DEMAND
         Change in Consumer Spending
         • Consumer wealth
         • Consumer expectations
         • Consumer indebtedness
         • Taxes
           Change in Investment Spending
         • Interest rates




Key concepts chapters 9 – 12!
        DETERMINANTS OF AGGREGATE DEMAND
         Change in Consumer Spending
         • Consumer wealth
         • Consumer expectations
         • Consumer indebtedness
         • Taxes
           Change in Investment Spending
         • Interest rates
         • Profit expectations on investment projects



Key concepts chapters 9 – 12!
        DETERMINANTS OF AGGREGATE DEMAND
         Change in Consumer Spending
         • Consumer wealth
         • Consumer expectations
         • Consumer indebtedness
         • Taxes
           Change in Investment Spending
         • Interest rates
         • Profit expectations on investment projects
         • Technology


Key concepts chapters 9 – 12!
        DETERMINANTS OF AGGREGATE DEMAND
         Change in Consumer Spending
         • Consumer wealth
         • Consumer expectations
         • Consumer indebtedness
         • Taxes
           Change in Investment Spending
         • Interest rates
         • Profit expectations on investment projects
         • Technology
         • Degree of excess capacity – Inventory!

Key concepts chapters 9 – 12!
        DETERMINANTS OF AGGREGATE DEMAND

         Change in Government Spending




Key concepts chapters 9 – 12!
        DETERMINANTS OF AGGREGATE DEMAND

         Change in Government Spending
         Change in Net Export Spending




Key concepts chapters 9 – 12!
        DETERMINANTS OF AGGREGATE DEMAND

         Change in Government Spending
         Change in Net Export Spending
            • National income abroad




Key concepts chapters 9 – 12!
        DETERMINANTS OF AGGREGATE DEMAND

         Change in Government Spending
         Change in Net Export Spending
            • National income abroad
            • Exchange rates


                                illustrated...
Key concepts chapters 9 – 12!
Changes in the Aggregate Demand Curve


       Aggregate expenditures
         (billions of dollars)
                                                    (C a + I g + X n + G) 1 at P 1


                                                       An Increase
                                                      in Aggregate
                                                      Expenditures
                                 0
                                      GDP1
             Price level




                                                     An Increase in
                                 P1                Aggregate Demand

                                             AD1
                                 0    GDP1
Changes in the Aggregate Demand Curve


       Aggregate expenditures
                                                      (C a + I g + X n + G) 2 at P 1




         (billions of dollars)
                                                      (C a + I g + X n + G) 1 at P 1


                                                         An Increase
                                                        in Aggregate
                                                        Expenditures
                                 0
                                      GDP1GDP2
             Price level




                                                       An Increase in
                                 P1                  Aggregate Demand
                                                  AD2
                                                 AD1
                                 0    GDP1GDP2
      Aggregate Supply:
      ...the level of real domestic output
      which will be produced at each
      price level




Key concepts chapters 9 – 12!
      Aggregate Supply:
      ...has three ranges:




Key concepts chapters 9 – 12!
      Aggregate Supply:
      ...has three ranges:

               1 - Horizontal Range




Key concepts chapters 9 – 12!
      Aggregate Supply:
      ...has three ranges:

               1 - Horizontal Range

               2 - Vertical Range



Key concepts chapters 9 – 12!
      Aggregate Supply:
      ...has three ranges:

               1 - Horizontal Range

               2 - Vertical Range

               3 - Intermediate (Upsloping) Range

Key concepts chapters 9 – 12!
As developed in chapter 8...
     P

                                           Vertical
    Price level

                                           Range
                  Horizontal
                   Range
                                                Upsloping or
                                                Intermediate
                                                   Range

                                                      Q
                    Real domestic output, GDP
An Increase in Aggregate Supply
     P                             AS1
    Price level




                                              Q
                  Real domestic output, GDP
An Increase in Aggregate Supply
     P                             AS1AS2
    Price level




                                              Q
                  Real domestic output, GDP
A Decrease in Aggregate Supply
    P                             AS1AS2
   Price level




                                             Q
                 Real domestic output, GDP
A Decrease in Aggregate Supply
    P                         AS3AS1AS2
   Price level




                                             Q
                 Real domestic output, GDP
        DETERMINANTS OF AGGREGATE SUPPLY
       When per unit production costs change firms will alter the
       amount they produce at each level. What would cause the
       per unit production costs to change?




Key concepts chapters 9 – 12!
        DETERMINANTS OF AGGREGATE SUPPLY
         Change in Input Prices




Key concepts chapters 9 – 12!
        DETERMINANTS OF AGGREGATE SUPPLY
         Change in Input Prices
         • Domestic resource availability




Key concepts chapters 9 – 12!
        DETERMINANTS OF AGGREGATE SUPPLY
         Change in Input Prices
         • Domestic resource availability
            • Land




Key concepts chapters 9 – 12!
        DETERMINANTS OF AGGREGATE SUPPLY
         Change in Input Prices
         • Domestic resource availability
            • Land
            • Labor




Key concepts chapters 9 – 12!
        DETERMINANTS OF AGGREGATE SUPPLY
         Change in Input Prices
         • Domestic resource availability
            • Land
            • Labor
            • Capital – (Expectations)




Key concepts chapters 9 – 12!
        DETERMINANTS OF AGGREGATE SUPPLY
         Change in Input Prices
         • Domestic resource availability
            • Land
            • Labor
            • Capital
            • Entrepreneurial ability




Key concepts chapters 9 – 12!
        DETERMINANTS OF AGGREGATE SUPPLY
         Change in Input Prices
         • Domestic resource availability
            • Land
            • Labor
            • Capital
            • Entrepreneurial ability
           Change in Productivity



Key concepts chapters 9 – 12!
        DETERMINANTS OF AGGREGATE SUPPLY
         Change in Input Prices
         • Domestic resource availability
            • Land
            • Labor
            • Capital
            • Entrepreneurial ability
           Change in Productivity
                                real output
           Productivity =         input

Key concepts chapters 9 – 12!
        DETERMINANTS OF AGGREGATE SUPPLY


       Change in legal-institutional
       environment




Key concepts chapters 9 – 12!
        DETERMINANTS OF AGGREGATE SUPPLY


       Change in legal-institutional
       environment
        • Business taxes and subsidies




Key concepts chapters 9 – 12!
        DETERMINANTS OF AGGREGATE SUPPLY


       Change in legal-institutional
       environment
        • Business taxes and subsidies

        • Government regulation


Key concepts chapters 9 – 12!
 The Equilibrium Price Level
and the Equilibrium Real GDP
   P                             AS
                                      Equilibrium in the
                                      intermediate range
  Price level




                                      AD
                         Q1   Qe Q2           Q
                Real domestic output, GDP
 The Equilibrium Price Level
and the Equilibrium Real GDP
   P                           AS
  Price level




                                    Equilibrium in the
                                    horizontal range


                              AD
                   Q1 Qe Q2
                                             Q
                Real domestic output, GDP
 The Equilibrium Price Level
and the Equilibrium Real GDP
   P                                AS
  Price level



                AD1
                                         Equilibrium in the
                                         horizontal range



                         Q1
                                                  Q
                      Real domestic output, GDP
 The Equilibrium Price Level
and the Equilibrium Real GDP
   P                                AS
  Price level



                AD1
                                         Equilibrium in the
                                         horizontal range


                                  AD2

                         Q1 Q2
                                                  Q
                      Real domestic output, GDP
 The Equilibrium Price Level
and the Equilibrium Real GDP
   P                                AS


                      AD1
  Price level


                                           Equilibrium in the
                                           intermediate range



                P1




                               Q1
                                                 Q
                     Real domestic output, GDP
 The Equilibrium Price Level
and the Equilibrium Real GDP
   P                               AS


                      AD1
  Price level


                                              Equilibrium in the
                                              intermediate range

                P3
                P1

                                        AD2

                               Q1 Q2
                                                    Q
                     Real domestic output, GDP
 The Equilibrium Price Level
and the Equilibrium Real GDP
   P                                 AS    Equilibrium in the
                                           vertical range
                               AD1
  Price level



                P5




                P1




                                     Qc
                                                 Q
                     Real domestic output, GDP
 The Equilibrium Price Level
and the Equilibrium Real GDP
   P                                 AS    Equilibrium in the
                                           vertical range
                P6
                               AD1
  Price level



                P5




                P1

                                                 AD2

                                     Qc
                                                 Q
                     Real domestic output, GDP
                     The Multiplier with
                     Price Level Changes
               P                         AS
  Full
Multiplier
                          AD1
                                                 Reduced
       Price level




                                                 Multiplier
                     P3         }
                     P1
                                    }
                                                AD2


                           GDP1    GDP2 GDP3
                                                      Q
                          Real domestic output, GDP
Illustrates
                       The Ratchet Effect
the down-                                            AS
ward
                       P
inflexibility
of prices.                                               Why the ratchet?
                                                               next...
                Price level




                                           c
                              P3
                                                     b
                                               a
                              P1

                                                     AD1 / 3   AD2

                                          Q2   Q1   Q3               Q
                                   Real domestic output, GDP
                   The Ratchet Effect
       C
       a
       u
       s
       e
       s

Key concepts chapters 9 – 12!
                   The Ratchet Effect
       C • Wage Contracts
       a
       u
       s
       e
       s

Key concepts chapters 9 – 12!
                   The Ratchet Effect
       C • Wage Contracts
       a • Morale & Productivity
       u
       s
       e
       s

Key concepts chapters 9 – 12!
                   The Ratchet Effect
       C • Wage Contracts
       a • Morale & Productivity
       u • Efficiency Wages
       s
       e
       s

Key concepts chapters 9 – 12!
                   The Ratchet Effect
       C • Wage Contracts
       a • Morale & Productivity
       u • Efficiency Wages
       s • Training Investments
       e
       s

Key concepts chapters 9 – 12!
                   The Ratchet Effect
       C        • Wage Contracts
       a        • Morale & Productivity
       u              • Efficiency Wages
       s        • Training Investments
       e        • Minimum Wage
       s

Key concepts chapters 9 – 12!
                   The Ratchet Effect
       C        • Wage Contracts
       a        • Morale & Productivity
       u              • Efficiency Wages
       s        • Training Investments
       e        • Minimum Wage
       s        • Menu Costs

Key concepts chapters 9 – 12!
                   The Ratchet Effect
       C        • Wage Contracts
       a        • Morale & Productivity
       u              • Efficiency Wages
       s        • Training Investments
       e        • Minimum Wage
       s        • Menu Costs
                • Fear of Price Wars
Key concepts chapters 9 – 12!
Shifting Aggregate Supply
         P                        AS2 AS1 AS3


                                                   Economic
                     Cost-push                     Growth
  Price level


                     inflation b
                                     a
                P2
                                               c
                P1
                P3
                                                     AD1

                                    Q2 Q1 Q3               Q
                      Real domestic output, GDP
Shifting Aggregate Supply
         P                        AS2 AS1 AS3




                        ANY Cost-push
  Price level



                                  b

                P2
                     QUESTIONS?
                              inflation
                                      a
                                               c
                P1
                P3
                                                   AD1

                                    Q2 Q1 Q3             Q
                      Real domestic output, GDP
   aggregate demand          intermediate range
   wealth effect             determinants of
   interest-rate effect       aggregate supply
   foreign purchases         productivity
    effect                    equilibrium price level
   determinants of           equilibrium real domestic
    aggregate demand           output
   aggregate supply          ratchet effect
   horizontal range          efficiency wages
   vertical range            menu costs
           Coming next....
                                 FISCAL
                                 POLICY


                                Chapter 12
Key concepts chapters 9 – 12!

				
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