Download AP econ Aggregate Demand and Aggregate Supply ppt

Aggregate expenditures &
aggregate demand
Chapters 10 and 11
Aggregate Expenditures approach
• Simplifications
– Closed private economy
– GDP=DI
– No exports, Gov’t
– Aggregate expenditures doesn’t impact price
Investment
Demand
Curve
Investment
Schedule
Investment
(billions of dollars)
Expected rate of return, r, and
real interest rate, i (percents)
INVESTMENT DEMAND & SCHEDULE
Ig
20
8
20
20
ID
20
Investment
(billions of dollars)
Real Domestic Product, GDP
(billions of dollars)
Private spending, C + I g (billions of dollars)
EQUILIBRIUM GDP
(C + I g = GDP)
$530
C + Ig
Equilibrium
510
C
490
470
Ig = $20 Billion
450
430
410
C =$450 Billion
390
370
45
o
o
370 390 410 430 450 470 490 510 530 550
Real domestic product, GDP (billions of dollars)
Private spending (billions of dollars)
CHANGES IN EQUILIBRIUM GDP
AND THE MULTIPLIER
510
Equilibrium GDP
GDP
at Ig1Equilibrium
level of investment
at Ig0 level of investment
(C + Ig )
1
(C + Ig )
490
0
Increases
in the level
of C + Ig
470
450
430
o
45
o
430
450
470
490
510
Real domestic product, GDP (billions of dollars)
Private spending (billions of dollars)
CHANGES IN EQUILIBRIUM GDP
AND THE MULTIPLIER
510
Equilibrium GDP
at Ig2 level of investment
(C + Ig )
0
(C + Ig )
490
2
470
Decreases
in the level
of C + Ig
450
430
o
45
o
430
450
470
490
510
Real domestic product, GDP (billions of dollars)
Net Exports, Xn
(billions of dollars)
Private spending (billions of dollars)
INTERNATIONAL TRADE AND
AGGREGATE EXPENDITURES
510
Aggregate Expenditures
with Negative Net Exports
C + Ig
C + Ig + Xn2
490
470
450
430
45 o
o
430
450
470
490
510
Real domestic product, GDP (billions of dollars)
+5
0
-5
430
450
470
490
510
Real GDP
ADDING THE PUBLIC SECTOR
Aggregate Expenditures (billions of dollars)
Government Purchases and Equilibrium GDP
C + Ig + Xn + G
Government
Spending of
$20 Billion
o
45
C + Ig + Xn
C
o
470
550
Real domestic product, GDP (billions of dollars)
ADDING THE PUBLIC SECTOR
Aggregate Expenditures (billions of dollars)
Lump-Sum Tax and Equilibrium GDP
$15 Billion Decrease
in Consumption from
a $20 Billion Increase
in Taxes
o
45
C + Ig + Xn + G
Ca + Ig + Xn + G
o
490
550
Real domestic product, GDP (billions of dollars)
FULL-EMPLOYMENT GDP
Aggregate Expenditures (billions of dollars)
Recessionary Gap
AE0
AE1
530
510
Recessionary Gap
= $5 Billion
490
Full Employment
o
45
o
490
510
530
Real domestic product, GDP (billions of dollars)
FULL-EMPLOYMENT GDP
Aggregate Expenditures (billions of dollars)
Inflationary Gap
530
AE2
AE0
Inflationary Gap
= $5 Billion
510
490
Full Employment
o
45
o
490
510
530
Real domestic product, GDP (billions of dollars)
PROBLEMS WITH AGGREGATE
EXPENDITURES APPROACH
• Does Not Show Price-Level Changes
• Ignores Premature Demand-Pull Inflation
• Limited Real GDP to the Full-Employment
Level
• Does not Deal with Cost-Push Inflation
• Does not Allow for “Self-correction”
AGGREGATE DEMAND
Defined:
•Amounts of Real Output
•Buyers Collectively Desire
•At Each Possible Price Level
Aggregate Demand Curve
Down Sloping Due To:
•Real-Balances Effect
•Interest-Rate Effect
•Foreign Purchases Effect
Graphically…
Price level
AGGREGATE DEMAND CURVE
AD
Real domestic output, GDP
Shifts in Aggregate Demand Caused
by Non-Price Level Factors
• Factors that Shift the Curve
Change in Consumer Spending
• Consumer Wealth
• Consumer
Expectations
• Household
Indebtedness
• Taxes
Change in Investment Spending
•
•
•
•
•
Interest Rates
Profit Expectations
Business Taxes
Technology
Degree of Excess
Capacity
Change in Government Spending
• Desire to add or
deduct from
government
supported programs.
Net Export Spending
•
•
•
•
Increased exports----Increased AD
Based on
1- national income abroad
2-exchange rates
AGGREGATE SUPPLY
Defined:
•Levels of Real Domestic
Output
•At Each Possible Price
Level
•Long-run Supply Curve
•Wages and Resource
Prices Match Price Level
•Short-run Supply Curve
•Wages and Resource
Prices Do Not Match
Price Level
AGGREGATE SUPPLY
Long Run
Price level
P
ASLR
Long-run
Aggregate
Supply
Full-Employment
Qf
Real domestic output, GDP
Q
AGGREGATE SUPPLY
Short Run
Price level
P
AS
Aggregate
Supply
Short-run
FullEmployment
Qf
Real domestic output, GDP
Q
Shifts in Aggregate Supply Caused
by Non-Price Level Factors
• Factors that Shift the Curve
Change in Input Prices
• Domestic Resource
Availability
• Prices of Imported
Goods
• Market Power
Change in Productivity
• Effect of Training
Programs
• Technology Gains
Change in Legal-Institutional
Environments
• Business Taxes
• Business Subsidies
• Government
Regulation
EQUILIBRIUM AND CHANGES
IN EQUILIBRIUM
Price Level
P
100
92
AS
a
b
Equilibrium
Real Output
AD
Q
Real Domestic Output, GDP
INCREASES IN AD:
DEMAND-PULL INFLATION
Price Level
P
AD1
AD2
AS
P2
P1
Qf
Q 1 Q2
Real Domestic Output, GDP
Q
DECREASES IN AD: RECESSION
& CYCLICAL UNEMPLOYMENT
Price Level
P
P1
AD2
AD1
b
AS
a
c
Q1
Qf
Real Domestic Output, GDP
Q
Ratchet Effect
• At full employment
• AD declines
– GDP declines but price does not
– “sticky” prices
•
•
•
•
•
Wage contracts
Efficiency wages
Min. wage
Menu cost
Fear price wars
DECREASES IN AS:
COST-PUSH INFLATION
AS2
Price Level
P
P2
P1
AS1
b
a
AD1
Q1 Qf
Real Domestic Output, GDP
Q
INCREASES IN AS:
FULL EMPLOYMENT
…With Price-Level Stability
AS1 AS2
P
Price Level
P3
P2
P1
b
a
AD1
AD2
Q1 Q2 Q3
Real Domestic Output, GDP
Q