EC4004 LECTURE 19 Aggregate Supply & Supply crises LAST TIME Stephen Kinsella Aggregate Demand: firstname.lastname@example.org AD = C + I + G + X-M NEWS. China, US, EU out of recession thanks to stimulus programmes. Read www.irisheconomy.ie, Philip Lane’s posts; Read TODAY. Ronanlyons.com. Live Register decreased from 425,500 in September to 422,500 in October, a fall of 3,000.. 1st fall since Jan. Aggregate Supply & Aggregate Demand (Cht 20) 2007, when the total was 156,600, and may reﬂect a rise in emigration. 086 399 83 06 FROM LAST TIME Aggregate Demand: AD = C + I + G + X-M SHIFTS IN THE AGGREGATE DEMAND CURVE Shifts in AD will be Inflation This would cause a Any exogenous caused by changes in rise causing factorin national I, factors affecting C, C,G Increase in the aggregate income (economic I or G to rise, or a and (X-M) (exogenous growth) and lead to factors) demand curve a surplus tradefall in e.g. increasing income causes a shift to unemployment (U = tax rates affect the right in AD 2%) (and vice versa) consumption 2.0% AD2 Increase in C,I, G, (X-M) AD Y1 Y2 U = 5% U = 2% Real National Income CHANGES IN AD: CHANGES IN AD: CONSUMPTION INVESTMENT Exogenous factors affecting consumption: Tax rates Spending on: Inﬂuenced by: Incomes – short term and expected income over lifetime Machinery Expected rates of return Wage increases Credit Equipment Interest rates Interest rates Wealth Buildings Expectations of future Property sales Shares Infrastructure Savings Expectations of future inﬂation rates Bonds CHANGES IN AD: GOVERNMENT KEY VARIABLES Defence (Write these down) Health Inﬂation Social Welfare Industry Growth Education Law and Order Unemployment Foreign Aid Balance of Payments (X-M) Regions KEY POLICIES Monetary Policy Don’t have one. (ECB) NOW. AGGREGATE SUPPLY Fiscal Policy Government spending & government income (taxes & borrowing) Supply-Side Policy Aggregate supply. Next lecture! AS: CAPACITY OF THE ECONOMY AGGREGATE SUPPLY Inflation AS Between Y1 and Yf, increases Yf shape of the Y1 Therepresents ofAS An output level‘Full Depends on in capacity are possible but the This shape reflects curve economy gets to would important in nearer theis suggest the –Yf, Employment Output’ the more problems are determining is working economy the outcome a Keynesian view at this point the experienced with acquiring in full capacity below the economy and economy boost production resources to is working to Costs of Production of the AS curve. (production and cannot there would be full capacity bottlenecks) widespread produce any more. especially labour skills Economy starts to overheat shortages. unemployment. Technology Productivity Education and Training Labour Market Incentives Tax regime Y1 Yf Real National Income Capital stock AGGREGATE SUPPLY AGGREGATE SUPPLY Inflation AS1 AS2 Inflation SRAS assumes Short run aggregate costs such as supply (SRAS) Increases in assumes firms rate overall wage only capacity can occur able to increase as a result of a remain fixed, output at higher shift in AS (akin to SRAS 1 changes in such costs (e.g. overtime a shift outwards of costs cause a shift payments) thereby the Production the SRAS curve inpushing up price Possibility Frontier) level (exogenous (PPF) SRAS shocks – input costs) SRAS 2 Yf1 Yf2 Real National Income Real National Income AGGREGATE SUPPLY AGGREGATE SUPPLY Inflation LRAS This is because they Inflation AS believe that in the long Classical For our analysis, we run, there will be no economists assume unemployment of will assume the AS the long run resources because curve looks like markets will clear, thus aggregate supply this! whatever the rate of curve (LRAS) is inflation, firms will supply vertical (perfectly the maximum capacity of inelastic). the economy. Yf Real National Income Real National Income PUTTING AD AND AS TOGETHER Putting AD and AS together A shift in the AD curve to Further increases in AD AS In this situation, of a AD1 as a result the AS Inflation economy would be change in any or all of Inflation would lead to successively smaller operating affecting AD the factorsat less than increases in growth capacity, there would be would increase growth, and employment at the unemployment and the reduce unemployment cost of ever higher economy might be but at a cost of higher inflation. inflation only slowly. growing (a trade-off) 3.5% AD2 2.5% 2.5% 2.0% 2.0% AD 1 AD1 AD AD Yf Y1 Y2 Yf Real National Income Y1 Y2 Y3 Real National Income SUSTAINED GROWTH 086 399 83 06 Inflation AS AS1 Sustained growth (not to be confused with sustainable economic growth) occurs when AS and AD rise at similar rates – national income can rise without effects on inflation 2.0% AD2 AD Y1 Y2 Real National Income CHANGES IN GOVERNMENT HOW FISCAL POLICY INFLUENCES PURCHASES AGGREGATE DEMAND !Fiscal policy refers to the government’s choices regarding the overall level of government purchases or taxes. !There are two macroeconomic effects !Fiscal policy inﬂuences saving, investment, and growth in the from the change in government long run. purchases: ! !In the short run, ﬁscal policy primarily affects the aggregate !The multiplier effect demand. !The crowding-out effect !Fiscalpolicy can be used to alter government purchases or to change taxes. THE MULTIPLIER EFFECT THE CROWDING-OUT EFFECT Price Level 2. …but the multiplier effect can amplify the shift in aggregate demand. !20 billion Fiscal policy may not affect the economy as strongly as predicted by the multiplier. AD3 An increase in government purchases causes the 1. An increase in government interest rate to rise. AD2 purchases of !20 billion initially increases aggregate demand Aggregate demand, AD1 A higher interest rate reduces investment spending. by !20 billion… 0 Quantity of Output AUTOMATIC STABILIZERS THE CROWDING-OUT EFFECT Automatic stabilizers are changes in ﬁscal policy that stimulate aggregate demand when the economy goes When the government increases its purchases by "20 into a recession without policymakers having to take any billion, the aggregate demand for goods and services deliberate action. could rise by more or less than "20 billion, depending on whether the multiplier effect or the crowding-out effect is larger. Automatic stabilizers include the tax system and some forms of government spending. FINALLY. SOME HOME TRUTHS • Ireland’s bloated public sector: Before the current recession Ireland’s government spending as a proportion of GDP was the lowest of any economy in the Euro Area, 33.6% in the years 2002-2006, compared to a Euro Area average of 47.4% . FROM WWW.PROGRESSIVE-ECONOMY.IE: France, Belgium and Austria, have a public sector which is SOME HOME TRUTHS proportionately 1# times greater than Ireland, at over 50% of GDP. • There is no scope to raise taxes: In the same 2002-2006 period Ireland’s tax take was also the lowest of any Euro Area economy, at 34.9% of GDP compared to Euro Area average of 44.9% of GDP. • There’s no scope for ﬁscal stimulus: Ireland’s output gap relative to potential GDP is expected to be up to 8.5% of GDP in 2009 and will still be as high as 5.4% of GDP in 2011, the largest in the Euro Area and compared to averages for the Euro Area as a whole of 3.6% this year and • Ireland has a uniquely high level of public debt: 2.5% in 2011. public debt level will rise to 96.2% of GDP in 2011, • Ireland’s • Ireland has become uncompetitive compared to 135.4% for Greece, 117.8% for Italy, 104% for internationally: 2002-2006, price deﬂator for Ireland’s Belgium and a Euro Area average of 88.2%. exports fell at an annual average rate of 2.7% and the price deﬂator for imports fell at an annual average rate of 2.3%, compared to Euro Area average rises of 0.5% and 0.7%. Ireland’s growth of per capita labour productivity was an annual average 2.2% compared to just 1.2% for the Euro Area, and 1.6% for Britain and 2.1% for the US 086 399 83 06 WRITE DOWN 2 THINGS YOU REMEMBER FROM TODAY. SUMMARY Aggregate Demand & Aggregate Supply Fiscal Policy Some home truths from TASC Blog.
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