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Unit 3-3: Aggregate Demand and Supply and Fiscal Policy 1 Shifters of Aggregate Demand AD = C + I + G + X Change in Consumer Spending Change in Investment Spending Change in Government Spending Net EXport Spending Shifters of Aggregate Supply AS = R + A + P Change in Change in Change in Resource Prices Actions of the Government Productivity 2 Putting AD and AS together to get Equilibrium Price Level and Output 3 Use the AD and AS model to show an economy at full employment output Price Level LRAS AS PLe AD QY GDPR 4 #1. Assume there is an increase in consumer spending. What happens to PL and output in the short- run? LRAS Price Level AS PL and Q will Increase PL1 PLe AD QY Q1 AD1 GDPR 5 Practice AD or AS Shifter Increase or Decrease 1 2 3 4 5 6 7 8 9 10 6 Practice 1. An increase in consumer spending 2. The impact on net exports when a trading partner has a recession 3. A significant increase in the price of oil that affects the resource costs of businesses 4. Government increases spending but not taxes 5. Increase in wages that businesses pay workers 6. Effect on businesses when they expect inflation 7. Effect on investment when interest rates decrease 8. An increase in productivity 9. The impact on next exports when the country’s currency depreciates 10. Government increases corporate taxes 7 Capital Goods The economy can only be in one of three places at any time Max Capacity 0% Unemployment Real GDP Real GDP Consumer Goods Full Employment 5% Unemployment Time Recessionary Gap Full Employment Inflationary Gap 8 Example: Assume the government increases spending. What happens to PL and Output? Price Level LRAS AS PL and Q will Increase PL1 PLe AD QY Q1 AD1 GDPR 9 Inflationary Gap Output is high and unemployment is less than NRU LRAS Price Level AS Actual GDP above potential GDP PL1 AD1 QY Q1 GDPR 10 Example: Assume consumer spending falls. What happens to PL and Output? LRAS Price Level AS PL and Q will decrease PLe PL1 AD1 Q1 QY AD GDPR 11 Recessionary Gap Output low and unemployment is more than NRU LRAS Price Level AS Actual GDP below potential GDP PL1 AD1 Q1 QY GDPR 12 Example: If there is a negative “supply shock” of oil. What happens to PL and Output? Price Level LRAS AS1 AS Stagflation PL1 Stagnate Economy + Inflation PLe Still considered recessionary gap AD Q1 QY GDPR 13 What Happens In the Long-Run? 14 If consumer spending increases, what will happen in the short-run and in the long-run? In the long-run, wages and costs increase LRAS AS1 Real GDP Price Level AS PL2 Real GDP PL1 PLe AD AD1 QY Q1 GDPR Time 15 If consumer spending increases, what will happen in the short-run and in the long-run? In the long-run, wages and costs increase LRAS AS1 Real GDP Price Level PLe Real GDP AD1 QY GDPR Time 16 If consumer spending decreases, what will happen in the short-run and in the long-run? In the long-run, wages & costs eventually decrease LRAS Price Level AS Real GDP AS2 PLe PL1 Real GDP PL2 AD2 AD Q1 QY GDPR Time 17 If investment increases, what happens in the short-run and long-run? Capital Stock- Machinery and tools purchased by businesses that increase their output LRAS LRAS1 AS AS1 PL1 PLe QY AD1 AD Q1 QY1 GDPR Capital Goods Price Level The PPC shifts outward since producers can make more Consumer Goods 18 An increase in consumption or government spending doesn’t cause economic growth. Only Investment causes growth since firms increase their capital stock LRAS1 AS1 Capital Goods Price Level PLe AD1 QY1 GDPR Consumer Goods 19