Download Eco 200 – Principles of Macroeconomics

Macroeconomic Equilibrium
(AD/AS)
Aggregate demand and supply
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Aggregate demand – a relationship
between the price level and the
equilibrium quantity of real GDP
demanded.
Aggregate supply – a relationship
between the price level and the
equilibrium quantity of real GDP
supplied.
Macroeconomic equilibrium
Demand-pull inflation

Demand-pull inflation is caused by an
increase in AD
Business cycle expansion

As AD rises, output rises, and unemployment
falls
Business cycle contraction

As AD falls, output falls and unemployment
rises
Cost-push inflation

Cost-push inflation is caused by a reduction in
AS.
Stagflation

Rising prices and falling output
Aggregate demand

Aggregate demand (AD) consists of spending
on GDP by:
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consumers (C)
firms (I)
the government (G), and
the foreign sector (X)
Anything that increases C, I, G, or X at a
given price level results in an increase in AD.
Factors affecting Consumption
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Income
Wealth
Expected future income and wealth
Demographics
Taxes
Factors affecting Investment
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Interest rate
Technology
Cost of capital goods
Capacity utilization
Government spending

Determined by government authorities
Factors affecting net exports
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Foreign and domestic income
Foreign and domestic price levels
Exchange rates
Government policy (tariffs, trade
restrictions, etc.)
Aggregate expenditures
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AE = C+I+G+X
AE is affected by any factor that
changes C, I, G, or X.
Aggregate demand

Note that AD curve is not the same as
the demand curve for a particular good

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negative slope is NOT the result of income
and substitution effects
Why is it downward sloping?
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Wealth effect
Interest rate
International trade effect
Wealth effect

As the price level rises:
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the real value of dollar-denominated assets
decline (real wealth declines)
this decline in wealth results in a reduction
in consumption spending
This affect is also called the realbalance effect (or Pigou effect)
Interest-rate effect

As the price level rises:

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Individuals must hold more money to pay for
transactions
To acquire more money, households sell bonds,
and other financial assets.
As more bonds are sold, the price of bonds
declines
A decline in bond prices results in a higher rate of
return (interest rate) on bonds and other financial
assets
A higher interest rate results in a reduction in
investment and consumption spending
International trade effect

As the domestic price level rises:
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Imports become relatively cheaper,
Exports become relatively more expensive
Exports decline, imports rise, and net
exports decline
Combined price-level effects

As the price level rises, AE falls due to
the combined wealth, interest-rate, and
international trade effects
Nonprice determinants of AD

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Anything that changes C, I, G, or X at a
given price level will cause the AD curve
to shift
Effects of:
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Expectations (consumer and investor
confidence)
Foreign income and price levels
Government policy
Aggregate supply

Price-level effects
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Assumption: Resource prices adjust more
slowly than output prices
As price level rises, production becomes
more profitable and the quantity of output
supplied rises.
Aggregate supply
Short-run Aggregate Supply
Long-run Aggregate Supply
Resource and output prices
are assumed to be flexible in
the long run. Output =
potential real GDP.
Changes in Short-Run AS
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Resource prices
Technology
Expectations
Changes in Long-Run AS
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Changes in the quantity and/or quality
of resources
Technology
Macroeconomic equilibrium
Short-run effect of an increase
in AD
Long-run adjustment process