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#7 Aggregate Demand and Aggregate Supply McGraw-Hill/Irwin Copyright © 2013 by The McGraw-Hill Companies, Inc. All rights reserved. Aggregate Demand • Real GDP desired at each price level • Inverse relationship • Real balances effect • Interest effect • Foreign purchases effect LO1 7-2 Price level Aggregate Demand AD 0 LO1 Real domestic output, GDP 7-3 Changes in Aggregate Demand • Determinants of aggregate demand • Change in consumer spending • Change in investment spending • Change in government spending • Change in export spending LO1 7-4 Price level Changes in Aggregate Demand AD2 AD3 AD1 0 Real domestic output, GDP LO1 7-5 Consumer Spending • Consumer wealth • Household borrowing • Consumer expectations • Personal taxes LO1 7-6 Investment Spending • Real interest rates • Expected returns • Expectations about future business conditions • Technology • Degree of excess capacity • Business taxes LO1 7-7 Investment Spending LO1 7-8 Government Spending • Government spending increases • Aggregate demand increases (as • LO1 long as interest rates and tax rates do not change) • More transportation projects Government spending decreases • Aggregate demand decreases • Less military spending 7-9 Net Export Spending • National income abroad • Exchange rates • Dollar depreciation • Dollar appreciation LO1 7-10 Net Export Spending LO1 7-11 Aggregate Supply • Total real output produced at each • LO2 price level Relationship depends on time horizon • Immediate short run • Short run • Long run 7-12 AS: Immediate Short Run Price level Immediate-short-run aggregate supply P1 0 ASISR Qf Real domestic output, GDP LO2 7-13 Aggregate Supply: Short Run AS Price level Aggregate supply (short run) 0 Qf Real domestic output, GDP LO2 7-14 Aggregate Supply: Long Run Price level ASLR Long-run aggregate supply 0 Qf Real domestic output, GDP LO2 7-15 Changes in Aggregate Supply • Determinants of aggregate supply • Change in input prices • Change in productivity • Change in legal-institutional • • LO2 environment Collectively position the AS curve Changes raise or lower per-unit production costs 7-16 Changes in Aggregate Supply AS3 AS1 Price level AS2 0 Real domestic output, GDP LO2 7-17 Input Prices • Domestic resource prices • Labor • Capital • Land • Prices of imported resources • Imported oil • Exchange rates LO2 7-18 Productivity • Real output per unit of input • Increases in productivity reduce costs • Decreases in productivity increase costs Productivity = Per-unit production cost LO2 Total output Total inputs = Total input cost Total output 7-19 Legal-Institutional Environment • Legal changes alter per-unit costs of output • Taxes and subsidies • Extent of government regulation LO2 7-20 Price level (index numbers) Equilibrium AS 100 a 92 b AD 0 502 Real Output Demanded (billions) Price Level (index number) Real Output Supplied (billions) $506 108 $513 508 104 512 510 100 510 512 96 507 514 92 502 510 514 Real domestic output, GDP (billions of dollars) LO3 7-21 AD Increases: Demand-Pull Inflation Price level AS P2 P1 AD2 AD1 0 Qf Q1 Q2 Real domestic output, GDP LO4 7-22 Decreases in AS: Cost-Push Inflation Price level AS2 AS1 b P2 P1 a AD 0 Q1 Qf Real domestic output, GDP LO4 7-23 Downward Price-Level Inflexibility • Prices are downwardly inflexible • Fear of price wars • Menu costs • Wage contracts • Efficiency wages • Minimum wage law LO4 7-24 Decreases in AD: Recession Price level AS P1 P2 b a c AD1 AD2 0 Q1 Q2 Qf Real domestic output, GDP LO4 7-25 The Multiplier Effect • Shifts in AD embody an “initial • change” in spending Price levels and average wage levels are becoming more flexible downward Change in real GDP Multiplier = LO4 Initial change in spending 7-26
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