Download Economics R. Glenn Hubbard, Anthony Patrick O’Brien, 2e.

Learning Objective 12.1
Chapter 12: Aggregate Demand and Aggregate Supply Analysis
What we learned in last class:
Economic growth since 1950 in the U.S.
Three reasons to explain the productivity slowdown of 1973-1974
Measurement errors.
High Oil price.
Declining labor quality.
Why Has Productivity Growth Been Faster in the United States than in
Other Countries.
Catch-up (convergence) theory.
Among industrial countries vs. General
Why Don’t More Low-Income Countries Experience Rapid Growth?
Failure to Enforce the Rule of Law
Wars and Revolutions
Poor Public Education and Health
Low Rates of Saving and Investment
Benefits of globalization.
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Aggregate Demand
and Aggregate Supply
Learning Objectives
12.1 Identify the determinants of
aggregate demand and distinguish
between a movement along the
aggregate demand curve and a
shift of the curve.
12.2 Identify the determinants of
aggregate supply and distinguish
between a movement along the
short- run aggregate supply curve
and a shift of the curve.
12.3 Use the aggregate demand and
aggregate supply model to illustrate
the difference between short-run and
long-run macroeconomic equilibrium.
To understand why FedEx and
other firms are affected by the
business cycle, we need to explore
the effects that recessions and
expansions have on production,
employment, and prices.
12.4 Use the dynamic aggregate demand
and aggregate supply model to
analyze macroeconomic conditions.
APPENDIX Understand macroeconomic
schools of thought.
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Learning Objective 12.1
Chapter 12: Aggregate Demand and Aggregate Supply Analysis
Aggregate Demand
Aggregate demand and aggregate supply model
A model that explains short-run fluctuations in real
GDP and the price level.
FIGURE 12.1
Aggregate Demand and
Aggregate Supply
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Learning Objective 12.1
Chapter 12: Aggregate Demand and Aggregate Supply Analysis
Aggregate Demand
Aggregate demand curve A curve that shows
the relationship between the price level and the
quantity of real GDP demanded by households,
firms, and the government.
Short-run aggregate supply curve A curve that
shows the relationship in the short run between
the price level and the quantity of real GDP
supplied by firms.
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Learning Objective 12.1
Chapter 12: Aggregate Demand and Aggregate Supply Analysis
Aggregate Demand
Why Is the Aggregate Demand Curve Downward Sloping?
GDP has four components: consumption (C),
investment (I), government purchases (G), and net
exports (NX). If we let Y stand for GDP, we can write
the following:
AD=Y = C + I + G + NX
The Wealth Effect: How a Change in the Price Level
Affects Consumption
The impact of the price level on consumption is called
the wealth effect.
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Learning Objective 12.1
Chapter 12: Aggregate Demand and Aggregate Supply Analysis
Aggregate Demand
Why Is the Aggregate Demand Curve Downward Sloping?
The Interest-Rate Effect: How a Change in the Price
Level Affects Investment
The impact of the price level on investment is
known as the interest-rate effect.
The International-Trade Effect: How a Change in
the Price Level Affects Net Exports
The impact of the price level on net exports is
known as the international-trade effect.
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Learning Objective 12.1
Chapter 12: Aggregate Demand and Aggregate Supply Analysis
Aggregate Demand
Shifts of the Aggregate Demand Curve versus
Movements Along It
An important point to remember is that the aggregate
demand curve tells us the relationship between the
price level and the quantity of real GDP demanded,
holding everything else constant.
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Learning Objective 12.1
Chapter 12: Aggregate Demand and Aggregate Supply Analysis
Aggregate Demand
The Variables That Shift the Aggregate Demand Curve
The variables that cause the aggregate demand curve
to shift fall into three categories:
• Changes in government policies
• Changes in the expectations of
households and firms
• Changes in foreign variables
Don’t Let This Happen to YOU!
Be Clear Why the Aggregate Demand Curve Is Downward Sloping
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Learning Objective 12.1
Chapter 12: Aggregate Demand and Aggregate Supply Analysis
Aggregate Demand
The Variables That Shift the Aggregate Demand Curve
Changes in Government Policies
Monetary policy The actions the Federal
Reserve takes to manage the money
supply and interest rates to pursue
macroeconomic policy objectives.
Fiscal policy Changes in federal taxes
and purchases that are intended to achieve
macroeconomic policy objectives, such as
high employment, price stability, and high
rates of economic growth.
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Learning Objective 12.1
Chapter 12: Aggregate Demand and Aggregate Supply Analysis
Aggregate Demand
The Variables That Shift the Aggregate Demand Curve
Changes in the Expectations of Households and Firms
If households become more optimistic about their
future incomes, they are likely to increase their
current consumption.
Changes in Foreign Variables
If firms and households in other countries buy
fewer U.S. goods or if firms and households in the
United States buy more foreign goods, net exports
will fall, and the aggregate demand curve will shift
to the left.
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Learning Objective 12.1
Chapter 12: Aggregate Demand and Aggregate Supply Analysis
Making
the
Connection
In a Global Economy, How Can You Tell
the Imports from the Domestic Goods?
Is the Toyota Sienna as American as apple pie?
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Learning Objective 12.1
Chapter 12: Aggregate Demand and Aggregate Supply Analysis
Solved Problem
12-1
Movements along the Aggregate Demand Curve
versus Shifts of the Aggregate Demand Curve
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Learning Objective 12.1
Chapter 12: Aggregate Demand and Aggregate Supply Analysis
Aggregate Demand
The Variables That Shift the Aggregate Demand Curve
Changes in Foreign Variables
Table 12-1
Variables That Shift the Aggregate Demand Curve
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Learning Objective 12.1
Chapter 12: Aggregate Demand and Aggregate Supply Analysis
Aggregate Demand
The Variables That Shift the Aggregate Demand Curve
Changes in Foreign Variables
Table 12-1
Variables That Shift the Aggregate Demand Curve (continued)
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Learning Objective 12.2
Chapter 12: Aggregate Demand and Aggregate Supply Analysis
Aggregate Supply
The Long-Run Aggregate Supply Curve
Long-run aggregate supply curve A curve that shows the
relationship in the long run between the price level and the
quantity of real GDP supplied.
LRAS=Potential real GDP or Full employment GDP.
Changes in the price level do not affect potential real GDP.
Three factors affecting potential real GDP:
Technological change
Labor force
Capital stock
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Learning Objective 12.2
Chapter 12: Aggregate Demand and Aggregate Supply Analysis
Aggregate Supply
The Long-Run Aggregate Supply Curve
FIGURE 12.2
The Long-Run Aggregate
Supply Curve
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Learning Objective 12.2
Chapter 12: Aggregate Demand and Aggregate Supply Analysis
Aggregate Supply
The Short-Run Aggregate Supply Curve
The three most common explanations as to why a shortrun aggregate supply curve slopes upward include:
1 Contracts make some wages and prices “sticky.”
2 Firms are often slow to adjust wages.
3 Menu costs make some prices sticky.
Menu costs The costs to
firms of changing prices.
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Learning Objective 12.2
Chapter 12: Aggregate Demand and Aggregate Supply Analysis
Aggregate Supply
Shifts of the Short-Run Aggregate Supply Curve versus
Movements Along It
It is important to remember the difference between a shift
in a curve and a movement along a curve.
Variables That Shift the Short-Run Aggregate Supply Curve
Increases in the Labor Force and in the Capital Stock
Technological Change
Expected Changes in the Future Price Level
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Learning Objective 12.2
Chapter 12: Aggregate Demand and Aggregate Supply Analysis
Aggregate Supply
Variables That Shift the Short-Run Aggregate Supply Curve
Expected Changes in the Future Price Level
FIGURE 12.3
How Expectations of
the Future Price Level
Affect the Short-Run
Aggregate Supply
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Learning Objective 12.2
Chapter 12: Aggregate Demand and Aggregate Supply Analysis
Aggregate Supply
Variables That Shift the Short-Run Aggregate Supply Curve
Adjustments of Workers and Firms to Errors in Past
Expectations about the Price Level
Unexpected Changes in the Price of an Important
Natural Resource
Supply shock An unexpected
event that causes the short-run
aggregate supply curve to shift.
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Learning Objective 12.2
Chapter 12: Aggregate Demand and Aggregate Supply Analysis
Aggregate Supply
Variables That Shift the Short-Run Aggregate Supply Curve
Unexpected Changes in the Price of an Important
Natural Resource
Table 12-2
Variables That Shift the Short-Run Aggregate Supply Curve
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Learning Objective 12.2
Chapter 12: Aggregate Demand and Aggregate Supply Analysis
Aggregate Supply
Variables That Shift the Short-Run Aggregate Supply Curve
Unexpected Changes in the Price of an Important
Natural Resource
Table 12-2
Variables That Shift the Short-Run Aggregate Supply Curve (continued)
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Learning Objective 12.3
Chapter 12: Aggregate Demand and Aggregate Supply Analysis
What we learned in last class: Curves!!
We learned only two things:
AD, LRAS and SRAS: Definitions and slopes
Variables that shift those curves !!
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Chapter 12: Aggregate Demand and Aggregate Supply Analysis
Learning Objective 12.3
Macroeconomic Equilibrium
In the Short Run
Using AD and SRAS curves to analyze how changes in economic
conditions and policies affect real GDP and the price level (in short-run).
Examples:
Fed lowered interest rate.
Bush lifts oil drill ban.
Obama proposes to lower income tax on working-family.
Bush’s tax-rebate program.
I.T. innovation.
Immigrants flow to the U.S.
Declining labor quality
……, ……
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Chapter 12: Aggregate Demand and Aggregate Supply Analysis
Learning Objective 12.3
Macroeconomic Equilibrium
in the Long Run and the Short Run
FIGURE 12.4
Long-Run Macroeconomic
Equilibrium
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Chapter 12: Aggregate Demand and Aggregate Supply Analysis
Learning Objective 12.3
Macroeconomic Equilibrium
in the Long Run and the Short Run
Recessions, Expansions, and Supply Shocks
Because the full analysis of the aggregate demand and
aggregate supply model can be complicated, we begin
with a simplified case, using two assumptions:
1 The economy has not been experiencing any
inflation. The price level is currently 100, and
workers and firms expect it to remain at 100
in the future.
2 The economy is not experiencing any long-run
growth. Potential real GDP is $10.0 trillion
and will remain at that level in the future.
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Chapter 12: Aggregate Demand and Aggregate Supply Analysis
Learning Objective 12.3
Macroeconomic Equilibrium
in the Long Run and the Short Run
Recessions, Expansions, and Supply Shocks
Recession
FIGURE 12.5
The Short-Run and
Long-Run Effects of a
Decrease in Aggregate
Demand
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Chapter 12: Aggregate Demand and Aggregate Supply Analysis
Learning Objective 12.3
Macroeconomic Equilibrium
in the Long Run and the Short Run
Recessions, Expansions, and Supply Shocks
Expansion
FIGURE 12.6
The Short-Run and
Long- run Effects of an
Increase in Aggregate
Demand
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Chapter 12: Aggregate Demand and Aggregate Supply Analysis
Learning Objective 12.3
Macroeconomic Equilibrium
in the Long Run and the Short Run
Recessions, Expansions, and Supply Shocks
Supply Shock
Stagflation A combination
of inflation and recession,
usually resulting from a
supply shock.
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Chapter 12: Aggregate Demand and Aggregate Supply Analysis
Learning Objective 12.3
Macroeconomic Equilibrium
in the Long Run and the Short Run
Recessions, Expansions, and Supply Shocks
Supply Shock
FIGURE 12.7
The Short-Run and Long-Run Effects of a Supply Shock
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Chapter 12: Aggregate Demand and Aggregate Supply Analysis
Learning Objective 12.4
A Dynamic Aggregate Demand
and Aggregate Supply Model
We can create a dynamic aggregate demand and
aggregate supply model by making three changes to
the basic model.
• Potential real GDP increases continually,
shifting the long-run aggregate supply curve to
the right.
• During most years, the aggregate demand
curve will be shifting to the right.
• Except during periods when workers and firms
expect high rates of inflation, the short-run
aggregate supply curve will be shifting to the
right.
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Chapter 12: Aggregate Demand and Aggregate Supply Analysis
Learning Objective 12.4
A Dynamic Aggregate Demand
and Aggregate Supply Model
FIGURE 12.8
A Dynamic Aggregate Demand
and Aggregate Supply Model
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Chapter 12: Aggregate Demand and Aggregate Supply Analysis
Learning Objective 12.4
A Dynamic Aggregate Demand
and Aggregate Supply Model
What Is the Usual Cause of Inflation?
FIGURE 12.9
Using Dynamic Aggregate
Demand and Aggregate
Supply to Understand
Inflation
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Chapter 12: Aggregate Demand and Aggregate Supply Analysis
Learning Objective 12.4
A Dynamic Aggregate Demand
and Aggregate Supply Model
The Slow Recovery from the Recession of 2001
The recession of 2001 was caused by a decline in
aggregate demand. Several factors contributed to
this decline:
• The end of the stock market “bubble.”
• Excessive investment in information technology.
• The terrorist attacks of September 11, 2001.
• The corporate accounting scandals.
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Learning Objective 12.4
Chapter 12: Aggregate Demand and Aggregate Supply Analysis
Making
the
Connection
Does Rising Productivity Growth
Reduce Employment?
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Chapter 12: Aggregate Demand and Aggregate Supply Analysis
Learning Objective 12.4
A Dynamic Aggregate Demand
and Aggregate Supply Model
The Economy in 2007: Continuing Expansion
or Looming Recession?
In late 2007, economists were divided over whether the
twin blows of higher oil prices and a declining housing
sector would be sufficient to push the economy into a
recession.
The majority of economists forecast that growth in real
GDP would slow but that the economy would not tip into
recession.
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Learning Objective 12.4
Chapter 12: Aggregate Demand and Aggregate Supply Analysis
Making
the
Do Oil Shocks Still Cause Recessions?
Connection
FedEx’s trucks and jets have become more fuel efficient.
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Learning Objective 12.4
Chapter 12: Aggregate Demand and Aggregate Supply Analysis
Solved Problem
12-4
Showing the Oil Shock of 1974–1975 on a Dynamic
Aggregate Demand and Aggregate Supply Graph
ACTUAL
REAL GDP
POTENTIAL
REAL GDP
PRICE
LEVEL
1974 $4.32 trillion $4.35 trillion
34.7
1975 $4.31 trillion $4.50 trillion
38.0
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Chapter 12: Aggregate Demand and Aggregate Supply Analysis
Appendix
Macroeconomic Schools of Thought
Keynesian revolution The name given to the widespread
acceptance during the 1930s and 1940s of John Maynard Keynes’s
macroeconomic model.
These alternative schools of thought use models that differ
significantly from the standard aggregate demand and aggregate
supply model. We can briefly consider each of the three major
alternative models:
1 The monetarist model
2 The new classical model
3 The real business cycle model
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Chapter 12: Aggregate Demand and Aggregate Supply Analysis
Appendix
Macroeconomic Schools of Thought
The Monetarist Model
The monetarist model—also known as the neo-Quantity Theory of
Money model—was developed beginning in the 1940s by Milton
Friedman, an economist at the University of Chicago who was
awarded the Nobel Prize in Economics in 1976.
Monetary growth rule A plan for increasing the
quantity of money at a fixed rate that does not respond
to changes in economic conditions.
Monetarism The macroeconomic theories of Milton
Friedman and his followers; particularly the idea that
the quantity of money should be increased at a
constant rate.
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Chapter 12: Aggregate Demand and Aggregate Supply Analysis
Appendix
Macroeconomic Schools of Thought
The New Classical Model
The new classical model was developed in the mid-1970s by a
group of economists including Nobel laureate Robert Lucas of the
University of Chicago, Thomas Sargent of New York University,
and Robert Barro of Harvard University.
New classical macroeconomics The macroeconomic
theories of Robert Lucas and others, particularly the
idea that workers and firms have rational expectations.
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Chapter 12: Aggregate Demand and Aggregate Supply Analysis
Appendix
Macroeconomic Schools of Thought
The Real Business Cycle Model
Beginning in the 1980s, some economists, including Nobel
laureates Finn Kydland of Carnegie Mellon University and Edward
Prescott of Arizona State University, argued that Lucas was correct
in assuming that workers and firms formed their expectations
rationally and that wages and prices adjust quickly to supply and
demand but wrong about the source of fluctuations in real GDP.
Real business cycle model A macroeconomic model
that focuses on real, rather than monetary, causes of
the business cycle.
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