Download Document

Aggregate Demand
and Aggregate Supply
© 2003 South-Western/Thomson Learning
The Aggregate
Demand Curve
•The Price Level and the Money Market
•Deriving the Aggregate Demand Curve
•Understanding the AD Curve
•Movements Along the AD Curve
•Shifts of the AD Curve
The Aggregate Demand Curve
Aggregate Demand Curve
Price
Level
Real
GDP
Aggregate Supply Curve
The Aggregate Demand Curve
A rise in price level causes the
• money demand curve to shift
rightward
• interest rate to rise
• aggregate expenditure line to shift
downward
• equilibrium GDP to decrease
The Aggregate Demand Curve
(a)
Interest
Rate
9%
6%
M
(b)
Aggregate
Expenditure
($ Trillions)
s
AEr = 6%
AEr = 9%
E
H
E
H
d
M2
d
M1
500
Money
($ Billions)
6
10
(c)
Real GDP
($ Trillions)
Price
Level
H
140
E
100
AD
6
10
Real GDP
($ Trillions)
The Aggregate
Demand Curve
A rise in the price level causes a
decrease in equilibrium GDP.
Deriving the Aggregate
Demand Curve
Aggregate Demand (AD) Curve
A curve indicating equilibrium GDP
at each price level.
Understanding the Aggregate
Demand Curve
Each point on the AD curve
represents a short-run equilibrium
in the economy.
Understanding the Aggregate
Demand Curve
P768 fig 1
Price
goes up
Increase in
money
demand
r goes up
a and I P
go down
Equilibrium
GDP goes down
Understanding the Aggregate
Demand Curve
P768 fig 1
Price
goes
down
Decrease
in money
demand
r goes
down
a and I P
go up
Equilibrium
GDP goes up
Shifts of the Aggregate
Demand Curve
• When a change in the price level causes
equilibrium GDP to change, we move
along the AD curve.
• Whenever anything other than the price
level causes equilibrium GDP to change,
the AD curve itself shifts.
Shifts of the Aggregate Demand Curve
(a)
Real
Aggregate
Expenditure
($ Trillions)
AE 2
AE 1
H
E
10
13.5
Real GDP
($ Trillions)
(b)
Price
Level
100
H
E
AD1 AD2
10
13.5
Real GDP
($ Trillions)
Spending Shocks
The AD curve shifts rightward when
• government purchases
• investment spending
• autonomous consumption spending
• or net exports increase
• or when taxes decrease.
Spending Shocks
The AD curve shifts leftward when
• government purchases
• investment spending
• autonomous consumption spending
• or net exports decrease
• or when taxes increase.
Changes in the Money Supply
•An increase in the money supply shifts
the AD curve rightward.
•A decrease in the money supply shifts
the AD curve leftward.
(a)
Price
Level
Effects of Key
Changes on the
AD Curve
Price level
moves us leftward
along the AD curve
P3
Price level
moves us rightward
along the AD curve
P1
P2
AD
Q3
(b)
Price
Level
Entire AD curve
shifts rightward if:
• A, Ip, G, or NX increases
• Taxes decrease
• The money supply
increases
AD 2
AD 1
Q1
Price
Level
Q2
Real GDP
(c)
Entire AD curve
shifts leftward if:
• A, I p, G, or NX decreases
• Taxes increase
• The money supply
decreases
AD 1
AD 2
Real GDP
Real GDP
The Aggregate Supply Curve
• Prices and Costs in the Short Run
• Deriving the Aggregate Supply Curve
• Movements Along the AS Curve
• Shifts of the AS Curve
Costs and Prices
A firm sets the price of its products
as a markup over cost per unit.
Costs and Prices
The average percentage markup in
the economy is determined by
competitive conditions in the
economy.
Costs and Prices
In the short run
• the price level rises when there is an
economy-wide increase in unit costs,
and
• the price level falls when there is an
economy-wide decrease in unit costs.
Outputs, Costs, and the Price
Level
As total output increases
• Greater amounts of inputs may be
needed to produce a unit of output.
• The prices of non-labor inputs rise.
• The nominal wage rate rises.
Output, Costs, and the Price
Level
For a year or so after a change in
output, changes in the average
nominal wage are less important than
other forces that change unit costs.
Output, Costs, and the Price
Level
Assume that changes in output have no
effect on the nominal wage rate in the
short run. In the short run
• a rise in real GDP will also cause a rise in
the price level.
• a fall in real GDP will also cause a
decrease in the price level.
Deriving the Aggregate Supply
Curve
Aggregate Supply (AS) Curve
A curve indicating the price level
consistent with firms’ unit costs and
markups for any level of output over the
short run.
Deriving the Aggregate Supply Curve
Price
Level
AS
130
B
100
80
A
C
6
10
13.5
Real GDP
($ Trillions)
Movements Upward Along the
Aggregate Supply Curve
Prices of non-labor inputs go up
Real
GDP
goes up
Unit
costs
go up
Input requirements per unit of
output go up
Price
level goes
up
Movements Downward Along the
Aggregate Supply Curve
P768 fig 1Input requirements per unit of
output go down
Real GDP
goes
down
Unit
costs go
down
Prices of non-labor inputs go down
Price
level goes
down
Shifts of the Aggregate Supply
Curve
• When a change in real GDP causes
the price level to change, we move
along the AS curve.
• When anything other than a change in
real GDP causes the price level to
change, the AS curve itself shifts.
Shifts of the Aggregate
Supply Curve
Examples of changes that shift AS
• Changes in world oil prices
• Changes in the weather
• Technological change
• Adjustment to the long run
Shifts of the Aggregate Supply
Curve
Price
Level
AS2
AS1
140
L
100
A
10
Real GDP
($ Trillions)
(a)
Price
Level
Effects of Key
Changes on
the Aggregate
Supply Curve
AS
Real GDP
moves us rightward
along the AS curve
P2
Real GDP
moves us leftward
along the AS curve
P1
P3
Q3
Q1
(b)
Price
Level
Real GDP
(c)
AS2
Entire AS curve
shifts upward if
unit costs for any
reason besides an
increase in real GDP
Q2
AS1
Real GDP
Price
Level
AS1
Entire AS curve
shifts downward if
unit costs for any
reason besides a
decrease in real GDP
AS2
Real GDP
AD and AS Together:
Short-Run Equilibrium
Short-Run Macroeconomic Equilibrium
A combination of price level and GDP
consistent with both the AD and AS
curves
AD and AS Together:
Short-Run Equilibrium
Price
Level
AS
B
140
E
100
F
AD
6
10
14
Real GDP
($ Trillions)
What Happens
When Things Change?
• Demand Shocks in the Short Run
• Demand Shocks: Adjusting to the
Long Run
• The Long-Run Aggregate Supply
Curve
• Supply Shocks
What Happens
When Things Change?
Demand Shock
Any event that causes the AD curve to
shift.
Supply Shock
Any event that causes the AS curve to
shift.
Demand Shocks in the Short
Run
Price
Level
AS
130
H
100
J
E
AD2
AD1
10 12 13.5
Real GDP
($ Trillions)
Demand Shocks in the
Short Run
An increase in government purchases:
• the horizontal shift of the AD curve measures
how much real GDP would increase if the price
level remained constant.
• because the price level does rise, real GDP rises
by less than the horizontal shift in the AD
curve.
Increase in Government
Purchases
AD curve shifts leftward
GDP
G
Movement along new AD curve
Unit
cost
Price
Movement along AS curve
Money
demand
Interest
rate
a and
IP
GDP
Net Effect: GDP  but by less, due to effect of P 
Increase in Government
Purchases
AD curve shifts rightward
GDP
G
Movement along new AD curve
Unit
cost
Price
Movement along AS curve
Money
demand
Interest
rate
a and
IP
GDP
Net Effect: GDP  but by less, due to effect of P 
Increase in Money Supply
AD curve shifts rightward
Money
Supply
Interest
rate
a and
IP
GDP
Movement along new AD curve
Unit
costs
Price
Movement along AS curve
Money
demand
Interest
rate
a and
IP
GDP
Net Effect: GDP  but by less, due to effect of P 
Other Demand Shocks
A positive demand shock
• shifts the AD curve rightward and
increases both real GDP and the price
level in the short run.
A negative demand shock
• shifts the AD curve leftward and
decreases both real GDP and the price
level in the short run.
Demand Shocks: Adjusting to
the Long Run
In the short run, we treat the wage rate as given.
But in the long run, the wage rate can change.
• When output is above full employment, the
wage rate will rise, shifting the AS curve
upward.
• When output is below full employment, the
wage rate will fall, shifting the AS curve
downward.
Demand Shocks: Adjusting to
the Long Run
Price
Level
Long Run AS Curve
AS2
AS 1
P4
K
J
P3
P2
P1
H
E
AD2
AD 1
YFEY3 Y2
Real GDP
Demand Shocks: Adjusting to
the Long Run
Self-Correcting Mechanism
The adjustment process through which
price and wage changes return the
economy to full-employment output in
the long run.
Positive Demand Shocks:
Adjusting to the Long Run
Change in short-run equilibrium
P
and
Y 
Positive
demand shock
Y > YFE
Wage
rate
Unit
costs
Price
Long run adjustment process
Y  until
Y = YFE
Demand Shocks: Adjusting
to the Long Run
Price
Level
Long-Run AS CurveAS
1
AS2
P1
P2
E
N
P3
M
AD1
AD2
Y2 YFE
Real GDP
Negative Demand Shocks:
Adjusting to the Long Run
Change in short-run equilibrium
P
and
Y
Negative
demand shock
Y < YFE
Wage
rate
Unit
costs
Price
Long run adjustment process
Y  until
Y = YFE
Demand Shocks: Adjusting
to the Long Run
• When output exceeds its full-employment level,
wages will eventually rise, causing a rise in the
price level and a drop in GDP until full
employment is restored.
• When output is less than its full-employment
level, wages will eventually fall, causing a drop
in the price level and a rise in GDP until full
employment is restored.
The Long-Run Aggregate
Supply Curve
Long-Run Aggregate Supply Curve
A vertical line indicating all possible
output and price-level combinations at
which the economy could end up in the
long run
The Long-Run Aggregate
Supply Curve
The self-correcting mechanism shows us
that, in the long run, the economy will
eventually behave as the classical model
predicts.
Short-Run Effects of Supply
Shocks
In the short run, a negative supply
shock shifts the AS curve upward
• decreasing output
• increasing the price level.
Short-Run Effects of Supply
Shocks
Price
Level
Long-Run AS Curve
AS2
AS1
R
P2
P1
E
AD
Y2 YFE
Real GDP
Short-Run Effects of Supply
Shocks
Stagflation
The combination of falling output and
rising prices
Short-Run Effects of Supply
Shocks
A negative supply shock causes
stagflation in the short run.
Short-Run Effects of Supply
Shocks
A positive supply shock shifts the
AS curve downward, increasing
output and decreasing the price level.
Long-Run Effects of Supply
Shocks
In the long run, the economy selfcorrects after a supply shock, just as
it does after a demand shock.
Long-Run Effects of Supply
Shocks
When output differs from its fullemployment level, the wage rate
changes, and the AS curve shifts
until full employment is restored.
Some Important Provisos
About the AS Curve
• Some prices take time to adjust.
• In some industries, wages respond
quickly.
• There is more to the process of
recovering from a shock than the
adjustment of prices and wages.