Download Shifts in the AS Curve Aggregate Supply Shocks

Chapter 23:
Output and Prices
in the Short Run
Copyright © 2014 Pearson Canada Inc.
Chapter Outline/Learning Objectives
Section
Learning Objectives
After studying this chapter, you will be able to
23.1 The Demand Side
of the Economy
1.
explain why an exogenous change in the price level
shifts the AE curve and changes the equilibrium level
of real GDP.
2.
derive the aggregate demand (AD) curve and
understand what causes it to shift.
23.2 The Supply Side
of the Economy
3.
describe the meaning of the aggregate supply (AS)
curve and understand why it shifts when technology
or factor prices change.
23.3 Macroeconomic
Equilibrium
4.
explain how AD and AS shocks affect equilibrium real
GDP and the price level.
Copyright © 2014 Pearson Canada Inc.
Chapter 23, Slide 2
23.1 The Demand Side of the Economy
Exogenous Changes in the Price Level
An increase in P reduces the real value of money holdings.
A fall in P raises the real value of money holdings.
Changes in P also affect the wealth of bondholders and bond issuers
• but there is no change in aggregate wealth*
*Only if bonds are not held by foreigners.
Copyright © 2014 Pearson Canada Inc.
Chapter 23, Slide 3
Exogenous Changes in the Price Level
An increase in P thus reduces private-sector wealth:
• reduction in desired consumption
• downward shift in AE curve
There is also an effect on net exports:
• the NX function shifts downward
• further downward shift in AE curve
Conversely for a fall in P.
Copyright © 2014 Pearson Canada Inc.
Chapter 23, Slide 4
Fig. 23-1
Desired Aggregate Expenditure and the Price Level
An increase in P
reduces desired
aggregate expenditure:
AE shifts down,
equilibrium Y falls.
Copyright © 2014 Pearson Canada Inc.
Chapter 23, Slide 5
The Aggregate Demand Curve
The aggregate demand (AD) curve relates equilibrium real GDP to
the price level.
For any given P, the AD curve shows the level of real GDP for which
desired aggregate expenditure equals actual GDP.
Changes in the price level cause movements along the AD curve.
Copyright © 2014 Pearson Canada Inc.
Chapter 23, Slide 6
Fig. 23-2
Derivation of the AD Curve
Consider a rise in the
price level, from P0 to P2:
The AE curve shifts down,
but we move along the
AD curve.
(i) Aggregate expenditure
(ii) Aggregate demand
Copyright © 2014 Pearson Canada Inc.
Chapter 23, Slide 7
Fig. 23-3
The Simple Multiplier and Shifts in the AD Curve
Shifts in the AD Curve
(aggregate demand shocks)
Any shock that increases
equilibrium GDP at a
given price level shifts
the AD curve to the right.
(i) Aggregate expenditure
The horizontal shift of
the AD curve is the simple
multiplier times the change
in autonomous spending.
(ii) Aggregate demand
Copyright © 2014 Pearson Canada Inc.
Chapter 23, Slide 8
23.2 The Supply Side of the Economy
The Aggregate Supply Curve
The AS curve relates the price level to the quantity of output that
firms would like to produce and sell.
The AS curve is drawn for a given:
• level of technology
• set of factor prices
As unit costs rise with output, firms will produce more output only
if prices increase:
 AS curve is upward sloping
Copyright © 2014 Pearson Canada Inc.
Chapter 23, Slide 9
The Aggregate Supply Curve
The slope of the AS curve is increasing as output rises:
• when output is low, firms typically have excess capacity
 costs do not rise quickly
• when output is nearer Y*, costs rise as output rises
 firms need higher prices
EXTENSIONS IN THEORY 23-1
The Keynesian AS Curve
Copyright © 2014 Pearson Canada Inc.
Chapter 23, Slide 10
Shifts in Aggregate Supply Curve
Aggregate Supply Shocks
Fig. 23-5
Shifts in the AS Curve
Anything that increases
firms' costs causes the
AS curve to shift up:
• factor prices
• technology
Copyright © 2014 Pearson Canada Inc.
Chapter 23, Slide 11
23.3 Macroeconomic Equilibrium
Demand behaviour is
consistent with supply
behaviour only at the
intersection of the
two curves.
Fig. 23-6
Macroeconomic Equilibrium
E0 is the macroeconomic
equilibrium.
Copyright © 2014 Pearson Canada Inc.
Chapter 23, Slide 12
Changes in Macroeconomic Equilibrium
Demand shocks can either be expansionary or contractionary.
• direction of AD shift
Supply shocks can either be expansionary or contractionary.
• direction of the AS shift
In both cases, "expansionary" or "contractionary" refers to
the effect on equilibrium output.
Copyright © 2014 Pearson Canada Inc.
Chapter 23, Slide 13
Aggregate Demand Shocks
Demand shocks cause
P and Y to change in
the same direction.
Fig. 23-7
Aggregate Demand Shocks
Possible causes:
• ΔG > 0
• ΔI > 0
• ΔX > 0
• ΔC > 0
Copyright © 2014 Pearson Canada Inc.
Chapter 23, Slide 14
Fig. 23-8
The Multiplier When the Price Level Varies
The Mechanics of an AD Shift
The shock causes the AE
curve to shift upward, but
the rise in the price level
causes it to shift down.
With an upward sloping AS
curve, the multiplier is
smaller than the simple
multiplier.
(i) Aggregate expenditure
(ii) Aggregate demand
Copyright © 2014 Pearson Canada Inc.
Chapter 23, Slide 15
Fig. 23-9
The Effects of Increases in Aggregate Demand
The effect of any given
shift of the AD curve will
depend on the slope of
the AS curve.
The steeper the AS curve,
the greater the price effect
and the smaller the output
effect.
Copyright © 2014 Pearson Canada Inc.
Chapter 23, Slide 16
Aggregate Supply Shocks
Fig. 23-10 A Negative
Aggregate Supply Shock
Aggregate supply shocks
cause P and Y to change
in opposite directions.
(i) Aggregate expenditure
Possible causes:
• Δ price of inputs
• Δ wages
• Δ technology
Copyright © 2014 Pearson Canada Inc.
(ii) Aggregate demand and supply
Chapter 23, Slide 17
A Word of Warning
Many economic events (especially changes in the world prices
of raw materials) cause both aggregate demand and aggregate
supply shocks.
The overall effect on the economy depends on the relative
importance of the two separate effects.
LESSONS FROM HISTORY 23-1
The Asian Crisis and the Canadian Economy
Copyright © 2014 Pearson Canada Inc.
Chapter 23, Slide 18
MyEconLab
www.myeconlab.com
Copyright © 2014 Pearson Canada Inc.
The increase in the world price of oil from 2002 to 2008 was
dramatic, but many observers were surprised at its modest impact
on the Canadian economy. For more information on how changes in
oil prices affect Canada, and why the negative AS effect is smaller
now than in the 1970s, look for Oil Prices and the Canadian
Economy in the Additional Topics section of this book's MyEconLab.
Chapter 23, Slide 19