Download Price level

 Aggregate demand: Schedule indicating
spending plans of agents at alternative price
levels.
Any factor that would
shift the AE schedule
will shift AD as well
AD2
AD1
0
Y
AD1 to AD2 due to:
•Increase in income
•Increase in wealth
•Increase in consumer or
business confidence
•Population growth
•Lower taxes
AD2
AD1
0
Y
 to  due to
The wealth effect.
The interest rate
effect
The international
trade effect.


The interest rate
effect is poorly
explained by Boyes
& Melvin on pp. 207-208
AD1
0
Y
 Aggregate supply is the schedule indicating the
quantity to total output supplied at alternative price levels
AS1
AS2
AS1  AS2 due to:
•Rising input prices
(wages, intermediate
goods, raw materials)
•Decreased
productivity
0
Y
Productivity () means
the average output of a worker
per year, or alternatively:
 = Y/N
where N is total employment.
 depends on
the efficiency with
which labor is employed
in the production of
goods & services
 Let  denote average annual compensation of
employees (including benefits). Thus unit labor
cost (UCL) is defined as:
ULC =  /
Notice that compensation
can rise with no effect on ULC,
so long as productivity
keeps pace
AS1
An increase
in ULC at
every level
of Y will shift
AS to the left
AS2
Price level
P2
P1
0
Y1
Y
Many economists
think this accurately
describes the U.S.
situation in 1966-68
Price level
AS
2
AD2
1
AD1
0
Notice that both Y
and P increase
Y
LRAS
With the economy
at full-employment,
a change in
AD affects prices
--but not output,
real income, or employment
P2
AD2
P1
AD1
0
Y*
Y
Cost-push is
a drag since
Y decreases
and P increases
AS2
AS1
P2
P1
AD
0
Y1
Y2
Y
•Grain failures
•Anchovies
•Oil shocks
•Wage and salary pressures
Stagflation is the
simultaneous
presence of high
inflation and
unemployment
Date
Jan. 1972
Dec. 1973
Jan. 1974
April 1979
June 1979
Nov 1979
Aug. 1980
Oct. 1981
Price ($)
1.79
4.68
10.84
14.55
18.00
24.00
30.00
34.00
I’d call that a shock,
wouldn’t you? The story
of Joseph (see Old Testament)
suggests buffer stocks
as the remedy for
supply-shock
inflation
Price of One Barrel of 340 crude
oil
Source: The Petroleum Economist
Source: Economic Report of the President
Productivity and Costs, 1974-83
120
100
80
60
40
20
0
74
75
76
77
78
79
80
82
83
Productivity
93.2 95.1 97.9 99.7 101 99.5 99.2 100 102
Compensation
49.9 54.8 59.7 64.5 70.1
Unit Labor Cost 53.5 57.6
61
77
85.1 100 104
64.7 69.7 77.4 85.6 100 101
1982=100