Download Ch 12 Notes

Chapter 12
Aggregate Demand and Aggregate
Supply
McGraw-Hill/Irwin
McGraw-Hill/Irwin
Copyright © 2015 by McGraw-Hill Education. All rights reserved.
Copyright © 2012 by The McGraw-Hill Companies, Inc. All rights reserved.
Aggregate Demand
I.
Deriving Aggregate Demand (AD)
1.
AD is planned aggregate expenditure (AE=C+I+G+NX) on final
goods and services at different price levels.
2.
AD can be derived from NX
- As our price level (such as CPI) rises relative to the price level in the US, our
exports become less competitive. Also, US imports would now look cheaper
(holding the exchange rate constant).
- Therefore, as P↑, NX↓, AE drops (in units)  AD is negatively sloped.
3.
Shifts in AD
(i)
LO1
Basically, any changes other than the price of goods and services, such as
the (CPI), will shift the AD curve.
Aggregate Demand
(ii) Increase (decrease) in C confidence, I confidence, G, NX and a tax cut
(hike) that will increase (decrease) our AE will shift the AD curve to the
right (left).
(iii) For a given shift in AD, the larger (smaller) the multiplier, the larger
(smaller) is the shift.
4.
LO1
Graphically:
Aggregate Supply: Short Run (SR)
II. Deriving Aggregate Supply (AS): Short Run (SR)
1.
The SR AS curve is derived from GDP = Income approach.
(i) GDP=P*Y=Wages + Profits + Depreciation+ Indirect Taxes + Other Incomes
(ii) P = Wages + Profits + Depreciation+ Indirect Taxes + Other Incomes
Y
(iii) Along the short run AS curve, wages, depreciation, indirect taxes and
other incomes are constant. We want to trace out how changes in P will
affect profits and therefore, Y. Remember Y is real GDP in units.
(iv) If P↑, Profits will ↑ because wages (production costs) are constant, and
Y
hence the firms will want to ↑Y.
2.
LO2
As a result, the SR AS curve is upward-sloping.
Shifts in SR AS
3.
Shifts in SR AS curve
(i) A rise in wages will increase costs, AS shifts (left, right).
(ii) A drop in wages will decrease costs, AS shifts (left, right).
(iii) A rise in the price of oil, which is a main source of input or production
costs, shifts AS (left, right).
(iv) Other changes such as technology, labour force, education will also shift
AS. An improvement shifts AS to the (left, right).
4.
Graphically:
Aggregate Supply: Long Run (LR)
III. Deriving Aggregate Supply (AS): Long Run (LR)
1.
The shape of the LR AS:
(i)
In the long run, input prices and goods prices are flexible. Wage contracts
are up for renewal and wages can change.
(ii) If in the short run P has ↑ for some reason, and while wage contracts
were still in effect, nominal wages remain constant. This will ↑ profits of
the firms, so the firms produce more along the short run AS curve
because real wages have (increased, decreased).
(iii) What happens in the long run?
2.
LO2
As a result, the LR AS curve is (vertical, upward-sloping).
Shifts in LR AS
3.
Shifts in the LR AS
(i)
LR AS shifts (left, right) if labour force, capital stock, technology
rises/improves.
(ii) LR AS shifts (left, right) if labour force, capital stock, technology drops.
Natural disasters will also shift LR AS to the left.
4.
LO2
Graphically:
AD Shocks
V. AD Shocks
1.
AD Shocks and Adjustments
(i) To begin with, the economy is at the long run equilibrium.
(ii) Suppose consumer confidence falls. This will shift the ________ curve
from _______ to __________.
(iii) The P level _____________ from ______________ to ______________.
(iv) The short run actual Y ____________ from ____________ to __________.
(v) Output gap= ___________________, which is (positive, negative).
Actual unemployment rate is (higher, lower) than NRU via Okun’s law.
(vi) What can the government do to minimize this output gap?
(vii) It can (increase, decrease) G, shifts (AD, AS) to the (left, right) and close
the output gap.
→ Exercise: Try AD ↑, such as rise in taxes, drop in G, NX, etc.
LO4
AD Shocks
2.
Graphically:
AE
P
Y
Y
AS Shocks
VI. AS Shocks
1.
AS Shocks and Adjustments
(i) To begin with, the economy is at the long run equilibrium.
(ii) Suppose the price of imported gasoline rises. This will shift the ________
curve from _______ to __________.
(iii) The P level _____________ from ______________ to ______________.
(iv) The short run actual Y ____________ from ____________ to __________.
(v) Output gap= ___________________, which is (positive, negative).
Actual unemployment rate is (higher, lower) than NRU via Okun’s law.
(vi) What can the government do to minimize this output gap?
- Much more difficult choices.
→ Exercise: Try AS shifts right, such as fall in wages, improvement in technology, etc.
LO4
AS Shocks
2.
Government Responses
(i)
Case 1: Increase G or Decrease T
(ii) Case 2: Decrease G or Increase T
3.
Graphically:
P
P
Y
Y
Conclusions
VII. Effectiveness of Fiscal Policies
1.
Fiscal policies = government using changes in G and T to affect Y.
2.
Fiscal policies can be used to offset AD shocks – bring Y and P
back to their original positions.
3.
Fiscal policies cannot completely offset AS shocks – can only bring
one of Y and P back to its original position.