Aggregate Supply Supply crises by kfl11257


                          LECTURE 19
                             Aggregate Supply &
                                Supply crises

                                                                                  LAST TIME
                                     Stephen Kinsella                            Aggregate Demand:
                                                AD = C + I + G + X-M


                                                         China, US, EU out of recession thanks to stimulus programmes.
                                                         Read, Philip Lane’s posts; Read
               TODAY.                           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
               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
                                 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)


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

                CHANGES IN AD:
                 GOVERNMENT                                              KEY VARIABLES
                                                         (Write these down)
    Social Welfare              Industry
    Education                   Law and Order
    Foreign Aid
                                                         Balance of Payments (X-M)
                    KEY POLICIES

Monetary Policy

    Don’t have one. (ECB)
                                                             NOW. AGGREGATE SUPPLY
Fiscal Policy

    Government spending & government income (taxes &

Supply-Side Policy

    Aggregate supply. Next lecture!

          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)
                                                                                                           produce any more.
                                                                                                            especially labour skills
                                                                   Economy starts to overheat                    shortages.
    Education and Training
                                  Labour Market

    Tax regime                                                                    Y1            Yf
                                                                                                     Real National Income

    Capital stock
             AGGREGATE SUPPLY                                                        AGGREGATE SUPPLY
                           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
                                                         (PPF)                                      SRAS       shocks – input

                                                                                                    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
                                              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%

2.5%                                                                   2.5%

2.0%                                                                   2.0%
                                             AD 1                                                                 AD1

                                            AD                                                                  AD
                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


                Y1   Y2                 Real National Income
                                                                                        CHANGES IN GOVERNMENT
   HOW FISCAL POLICY INFLUENCES                                                              PURCHASES
!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
                                                                                        !The   crowding-out effect
!Fiscalpolicy can be used to alter government purchases or to
  change taxes.

             THE MULTIPLIER EFFECT                                                      THE CROWDING-OUT EFFECT
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.

                                                                                        An increase in government purchases causes the
         1. An increase in government
                                                                                        interest rate to rise.
        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

                                                                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

                                                          •   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
                                                                                                 FROM TODAY.

Aggregate Demand

& Aggregate Supply

Fiscal Policy

Some home truths from TASC Blog.

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