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Unit 3: Aggregate Demand and Supply and Fiscal Policy Copyright ACDC Leadership 2015 1 Shifters of Aggregate Demand AD = C + I + G + X Change in Consumer Spending Change in Investment Spending Change in Government Spending Net EXport Spending Shifters of Aggregate Supply AS = R + A + P Change in Change in Change in Copyright ACDC Leadership 2015 Resource Prices Actions of the Government Productivity 2 Putting AD and AS together to get Equilibrium Price Level and Output Copyright ACDC Leadership 2015 3 Use the AD and AS model to show an economy at full employment output Price Level LRAS AS PLe AD Copyright ACDC Leadership 2015 QY GDPR 4 #1. Assume there is an increase in consumer spending. What happens to PL and output in the short- run? LRAS Price Level AS PL and Q will Increase PL1 PLe AD Copyright ACDC Leadership 2015 QY Q1 AD1 GDPR 5 Practice AD or AS Shifter Increase or Decrease 1 2 3 4 5 6 7 8 9 10 Copyright ACDC Leadership 2015 6 Practice 1. An increase in consumer spending 2. The impact on net exports when a trading partner has a recession 3. A significant increase in the price of oil that affects the resource costs of businesses 4. Government increases spending but not taxes 5. Increase in wages that businesses pay workers 6. Effect on businesses when they expect inflation 7. Effect on investment when interest rates decrease 8. An increase in productivity 9. The impact on next exports when the country’s currency depreciates 10. Government increases corporate taxes 7 Practice AD or AS Shifter Increase or Decrease 1 2 AD AD C X Increase Decrease 3 4 5 6 7 AS AD AS AS AD R G R R I Decrease Increase Decrease Decrease Increase 8 AS P Increase 9 10 AD AS X A Increase Decrease Copyright ACDC Leadership 2015 8 Inflationary and Recessionary Gaps Copyright ACDC Leadership 2015 9 The economy can only be in one of three places at any time Capital Goods Max Capacity 0% Unemployment Real GDP Real GDP Consumer Goods Full Employment 5% Unemployment Copyright ACDC Leadership 2015 Time Recessionary Gap Full Employment Inflationary Gap 10 Example: Assume the government increases spending. What happens to PL and Output? Price Level LRAS AS PL and Q will Increase PL1 PLe AD Copyright ACDC Leadership 2015 QY Q1 AD1 GDPR 11 Inflationary Gap Output is high and unemployment is less than NRU LRAS Price Level AS Actual GDP above potential GDP PL1 AD1 Copyright ACDC Leadership 2015 QY Q1 GDPR 12 Example: Assume consumer spending falls. What happens to PL and Output? LRAS Price Level AS PL and Q will decrease PLe PL1 AD1 Copyright ACDC Leadership 2015 Q1 QY AD GDPR 13 Recessionary Gap Output low and unemployment is more than NRU LRAS Price Level AS Actual GDP below potential GDP PL1 AD1 Copyright ACDC Leadership 2015 Q1 QY GDPR 14 Example: If there is a negative “supply shock” of oil. What happens to PL and Output? Price Level LRAS AS1 AS Stagflation PL1 Stagnate Economy + Inflation PLe Still considered recessionary gap AD Copyright ACDC Leadership 2015 Q1 QY GDPR 15 2008 Audit Exam 2008 Audit Exam 2008 Audit Exam 2012 Exam AD and AS Practice Worksheet Copyright ACDC Leadership 2015 21 What Happens In the Long-Run? Copyright ACDC Leadership 2015 22 If consumer spending increases, what will happen in the short-run and in the long-run? In the long-run, wages and costs increase LRAS AS1 Real GDP Price Level AS PL2 Real GDP PL1 PLe AD AD1 Copyright ACDC Leadership 2015 QY Q1 GDPR Time 23 If consumer spending increases, what will happen in the short-run and in the long-run? In the long-run, wages and costs increase LRAS AS1 Real GDP Price Level PLe Real GDP AD1 Copyright ACDC Leadership 2015 QY GDPR Time 24 If consumer spending decreases, what will happen in the short-run and in the long-run? In the long-run, wages & costs eventually decrease LRAS Price Level AS Real GDP AS2 PLe PL1 Real GDP PL2 AD2 AD Copyright ACDC Leadership 2015 Q1 QY GDPR Time 25 Practice Copyright ACDC Leadership 2015 26 #1. Assume there is an increase in government spending. What happens to PL and output in the short- run? LRAS Price Level AS PL and Q will Increase PL1 PLe AD Copyright ACDC Leadership 2015 QY Q1 AD1 GDPR 27 #2. Consumer expectations fall and consumer spending plummets. What happens to price level and output in the long-run? Price Level LRAS AS AS1 Price Level decreases and output stay s the AD same PLe PL1 PL2 AD1 Copyright ACDC Leadership 2015 Q1 QY GDPR 28 #3. If consumer spending increases, what happens to price level and output in the long-run? Price Level LRAS AS1 AS PL2 Price level increases and output stays the same PL1 PLe AD Copyright ACDC Leadership 2015 QY Q1 AD1 GDPR 29 2008 Audit Exam Economic Growth Copyright ACDC Leadership 2015 31 If investment increases, what happens in the short-run and long-run? Capital Stock- Machinery and tools purchased by businesses that increase their output LRAS LRAS1 AS AS1 PL1 PLe Copyright ACDC Leadership 2015 QY AD1 AD Q1 QY1 GDPR Capital Goods Price Level The PPC shifts outward since producers can make more Consumer Goods 32 An increase in consumption or government spending doesn’t cause economic growth. Only Investment causes growth since firms increase their capital stock LRAS1 AS1 Capital Goods Price Level PLe AD1 Copyright ACDC Leadership 2015 QY1 GDPR Consumer Goods 33 2008 Audit Exam 2008 Audit Exam 2012 FRQ #3 36 2012 FRQ #3 37