Download Aggregate Demand and Aggregate Supply

Economics
NINTH EDITION
Chapter 9
Aggregate Demand
and Aggregate
Supply
Prepared by Brock Williams
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Learning Objectives
9.1 Explain the role sticky wages and prices play in
economic fluctuations.
9.2 List the determinants of aggregate demand.
9.3 Distinguish between the short run and long run
aggregate supply curves.
9.4 Explain how the short-run aggregate supply curve shifts
over time.
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9.1 STICKY PRICES AND THEIR
MACROECONOMIC CONSEQUENCES
Fluctuations in the economy can be seen as failures in coordination.
Flexible and Sticky Prices
• For most firms, the biggest cost of doing business is wages. If wages are sticky, firms’
overall costs will be sticky as well. This means that firms’ product prices will remain
sticky, too.
• Sticky wages cause sticky prices and hamper the economy’s ability to bring demand and
supply into balance in the short run.
How Demand Determines Output in the Short Run
• Short run in macroeconomics
The period of time in which prices do not change or do not change very much.
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APPLICATION 1
MEASURING PRICE STICKINESS IN CONSUMER MARKETS
APPLYING THE CONCEPTS #1: What does the behavior of prices in consumer
markets demonstrate about how quickly prices adjust in the U.S. economy?
To analyze the behavior of retail prices, economist Anil Kashyap of the University of
Chicago examined prices in consumer catalogs.
He looked at the prices of 12 selected goods from:
• L.L. Bean
• Recreational Equipment, Inc. (REI)
• The Orvis Company, Inc.
The goods included shoes, blankets, chamois shirts, binoculars, and a fishing rod and
fly.
What did he find?
• Considerable price stickiness.
• When prices did change, he observed a mixture of both large and small changes.
• During periods of high inflation, prices tended to change more frequently.
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9.2 UNDERSTANDING AGGREGATE
DEMAND (1 of 10)
What Is the Aggregate Demand Curve?
• Aggregate demand curve (AD)
A curve that shows the relationship between the level of prices and the quantity of real
GDP demanded.
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9.2 UNDERSTANDING AGGREGATE
DEMAND (2 of 10)
The Components of
Aggregate Demand
The aggregate demand curve plots the
total demand for real GDP as a function
of the price level.
The aggregate demand curve slopes
downward, indicating that the quantity of
aggregate demand increases as the
price level in the economy falls.
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9.2 UNDERSTANDING AGGREGATE
DEMAND (3 of 10)
Why the Aggregate Demand Curve Slopes Downward
REAL-NOMINAL PRINCIPLE
What matters to people is the real value of money or income—its purchasing
power—not the face value of money or income.
As the purchasing power of money changes, the aggregate demand curve is affected in
three different ways:
THE WEALTH EFFECT
• Wealth effect
The increase in spending that occurs because the real value of money increases when
the price level falls.
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9.2 UNDERSTANDING AGGREGATE
DEMAND (4 of 10)
Why the Aggregate Demand Curve Slopes Downward
THE INTEREST RATE EFFECT
With a given supply of money in the economy, a lower price level will lead to lower interest
rates.
With lower interest rates, both consumers and firms will find it cheaper to borrow money to
make purchases.
As a consequence, the demand for goods in the economy (consumer durables purchased
by households and investment goods purchased by firms) will increase.
THE INTERNATIONAL TRADE EFFECT
In an open economy, a lower price level will mean that domestic goods (goods produced in
the home country) become cheaper relative to foreign goods, so the demand for domestic
goods will increase.
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9.2 UNDERSTANDING AGGREGATE
DEMAND (5 of 10)
Shifts in the Aggregate Demand Curve
CHANGES IN THE SUPPLY OF MONEY
An increase in the supply of money in the economy will increase aggregate demand and
shift the aggregate demand curve to the right.
CHANGES IN TAXES
A decrease in taxes will increase aggregate demand and shift the aggregate demand curve
to the right.
CHANGES IN GOVERNMENT SPENDING
At any given price level, an increase in government spending will increase aggregate
demand and shift the aggregate demand curve to the right.
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9.2 UNDERSTANDING AGGREGATE
DEMAND (6 of 10)
Shifts in the Aggregate Demand
Curve
ALL OTHER CHANGES IN DEMAND
Decreases in taxes, increases in government
spending, and an increase in the supply of money
all shift the aggregate demand curve to the right.
Higher taxes, lower government spending, and a
lower supply of money shift the curve to the left.
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9.2 UNDERSTANDING AGGREGATE
DEMAND (7 of 10)
How the Multiplier
Makes the Shift Bigger
Initially, an increase in desired
spending will shift the
aggregate demand curve
horizontally to the right from a
to b.
The total shift from a to c will be
larger. The ratio of the total shift
to the initial shift is known as
the multiplier.
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9.2 UNDERSTANDING AGGREGATE
DEMAND (8 of 10)
How the Multiplier Makes the Shift Bigger
• Multiplier
The ratio of the total shift in aggregate demand to the initial shift in aggregate demand.
• Consumption function
•
The relationship between the level of income and consumer spending.
C = Ca + by
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9.2 UNDERSTANDING AGGREGATE
DEMAND (9 of 10)
How the Multiplier Makes the Shift Bigger
• Autonomous consumption spending
The part of consumption spending that does not depend on income.
• Marginal propensity to consume (MPC)
The fraction of additional income that is spent.
• Marginal propensity to save (MPS)
The fraction of additional income that is saved.
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9.2 UNDERSTANDING AGGREGATE
DEMAND (10 of 10)
How the Multiplier Makes the Shift Bigger
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APPLICATION 2
TWO APPROACHES TO DETERMINING THE CAUSES OF RECESSIONS
APPLYING THE CONCEPTS #2: How can we determine what factors cause recessions?
Economists have used the basic framework of aggregate demand and supply analysis to explain
recessions. Recessions can occur either when there is a sharp decrease in demand or a
decrease in aggregate supply.
Economic historian Peter Temin looked at all recessions from 1893 to 1990 to determine their
causes. He found, recessions were caused by many different factors.
• Sometimes, as in 1929, they were caused by shifts in aggregate demand from the private sector,
as consumers cut back their spending.
• Other times, as in 1981, the government cut back on aggregate demand to reduce inflation.
• Supply shocks were the cause of the recessions in 1973 and 1979.
• The most severe shock hit the U.S. economy in 1931 and converted an economic downturn into
the Great Depression. He believes that foreign monetary developments were the ultimate source
of this shock to the U.S. economy.
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9.3 UNDERSTANDING AGGREGATE
SUPPLY (1 of 7)
• Aggregate supply curve (AS)
A curve that shows the relationship between the level of prices and the quantity of output
supplied.
The Long-Run Aggregate Supply Curve
• Long-run aggregate supply curve
A vertical aggregate supply curve that represents the idea that in the long run, output is
determined solely by the factors of production.
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9.3 UNDERSTANDING AGGREGATE
SUPPLY (2 of 7)
The Long-Run Aggregate
Supply Curve
In the long run, the level of output,
yp, is independent of the price
level.
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9.3 UNDERSTANDING AGGREGATE
SUPPLY (3 of 7)
The Long-Run
Aggregate Supply
Curve
DETERMINING OUTPUT AND
THE PRICE LEVEL
Output and prices are determined
at the intersection of AD and AS.
An increase in aggregate demand
leads to a higher price level.
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9.3 UNDERSTANDING AGGREGATE
SUPPLY (4 of 7)
The Short-Run Aggregate Supply Curve
• Short-run aggregate supply curve
A relatively flat aggregate supply curve that represents the idea that prices do not
change very much in the short run and that firms adjust production to meet demand.
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9.3 UNDERSTANDING AGGREGATE
SUPPLY (5 of 7)
The Short-Run
Aggregate Supply
Curve
With a short-run aggregate
supply curve, shifts in
aggregate demand lead to
large changes in output but
small changes in price.
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9.3 UNDERSTANDING AGGREGATE
SUPPLY (6 of 7)
The Short-Run Aggregate Supply Curve
What factors determine the costs firms must incur to produce output? The key
factors are
• Input prices (wages and materials)
• The state of technology
• Taxes, subsidies, or economic regulations
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9.3 UNDERSTANDING AGGREGATE
SUPPLY (7 of 7)
Supply Shocks
• Supply shocks
External events that shift the
aggregate supply curve.
An adverse supply shock, such
as an increase in the price of
oil, will cause the AS curve to
shift upward.
The result will be higher prices
and a lower level of output.
• Stagflation
A decrease in real output with
increasing prices.
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APPLICATION 3
OIL PRICE DECLINES AND THE U.S. ECONOMY
APPLYING THE CONCEPTS #3: Do declines in oil prices always help the U.S.
Economy?
•
•
•
•
•
•
•
Economists have generally believed that falling oil prices will benefit the U.S. economy and lead to
higher economic growth.
Falling oil prices should lead to falling gasoline and heating oil prices and put more money in the
pockets of consumers that will lead to increases in aggregate demand.
Since fuel is an input into production, lower oil prices may also increase aggregate supply.
But the decrease in oil prices in 2014 and 2015 have had only a modest effect on economic growth.
Consumers appeared to have used the extra money to reduce overall debt instead of other
consumption.
Lower oil prices reduce the incentive for firms to produce energy and invest in new capital and
equipment.
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9.4 FROM THE SHORT RUN TO THE LONG
RUN (1 of 3)
In the short run, the
economy produces at y0,
which exceeds potential
output yp.
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9.4 FROM THE SHORT RUN TO THE LONG
RUN (2 of 3)
With output exceeding
potential, the short-run AS
curve shifts upward over
time.
The economy adjusts to
the long-run equilibrium at
a1.
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9.4 FROM THE SHORT RUN TO THE LONG
RUN (3 of 3)
Looking Ahead
• The aggregate demand and aggregate supply model in this chapter provides an
overview of how demand affects output and prices in both the short run and the long run.
• The next several chapters explore more closely how aggregate demand determines
output in the short run.
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KEY TERMS
Aggregate demand curve (AD)
Aggregate supply curve (AS)
Autonomous consumption spending
Consumption function
Long-run aggregate supply curve
Marginal propensity to consume (MPC)
Marginal propensity to save (MPS)
Multiplier
Short-run aggregate supply curve
Short run in macroeconomics
Stagflation
Supply shocks
Wealth effect
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