Download aggregate supply (AS) curve

Chapter
13
Aggregate Demand,
Aggregate Supply,
and Inflation
Prepared by:
Fernando & Yvonn Quijano
© 2007 Prentice Hall Business Publishing Principles of Economics 8e by Case and Fair
CHAPTER 13: Aggregate Demand,
Aggregate Supply, and Inflation
Aggregate Demand, Aggregate
Supply, and Inflation
13
Chapter Outline
The Aggregate Demand Curve
Deriving the Aggregate Demand Curve
The Aggregate Demand Curve: A Warning
Other Reasons for a Downward-Sloping Aggregate
Demand Curve
Aggregate Expenditure and Aggregate Demand
Shifts of the Aggregate Demand Curve
The Aggregate Supply Curve
The Aggregate Supply Curve: A Warning
Aggregate Supply in the Short Run
Shifts of the Short-Run Aggregate Supply Curve
The Equilibrium Price Level
The Long-Run Aggregate Supply Curve
Potential GDP
Aggregate Demand, Aggregate Supply, and
Monetary and Fiscal Policy
Long-Run Aggregate Supply and Policy Effects
Causes of Inflation
Inflation versus Sustained Inflation: A Reminder
Demand-Pull Inflation
Cost-Push, or Supply-Side, Inflation
Expectations and Inflation
Money and Inflation
Sustained Inflation as a Purely Monetary Phenomenon
Looking Ahead
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CHAPTER 13: Aggregate Demand,
Aggregate Supply, and Inflation
THE AGGREGATE DEMAND CURVE
aggregate demand The total demand
for goods and services in the economy.
Money demand is a function of three variables: the interest rate (r), the level of real
income (Y), and the price level (P). (Remember, Y is real output, or income. It measures
the actual volume of output, without regard to changes in the price level.) Money
demand will increase if the real level of output (income) increases, the price level
increases, or the interest rate declines.
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CHAPTER 13: Aggregate Demand,
Aggregate Supply, and Inflation
THE AGGREGATE DEMAND CURVE
DERIVING THE AGGREGATE DEMAND CURVE
FIGURE 13.1 The Impact of an Increase in the Price Level on the Economy–Assuming No
Changes in G, T, and Ms
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CHAPTER 13: Aggregate Demand,
Aggregate Supply, and Inflation
THE AGGREGATE DEMAND CURVE
DERIVING THE AGGREGATE DEMAND CURVE
aggregate demand curve
(AD) A curve that shows the
negative relationship
between aggregate output
(income) and the price level.
Each point on the AD curve
is a point at which both the
goods market and the money
market are in equilibrium.
FIGURE 13.2 The Aggregate Demand (AD) curve
An increase in the price level causes the level of aggregate output (income) to fall.
A decrease in the price level causes the level of aggregate output (income) to rise.
Each pair of values of P and Y on the aggregate demand curve corresponds to a point
at which both the goods market and the money market are in equilibrium.
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CHAPTER 13: Aggregate Demand,
Aggregate Supply, and Inflation
Let P equal the aggregate price level. Assuming
that G, T, and MS remain the same, the impact
of an increase in the price level on the
economy can be described as follows:
a.  P   M d   r   I   AE
b.  P   M d   r   I   AE
c.  P   M d   r   I   AE
d.  P   M d   r   I   AE
e.  P   M d   r   I   AE
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CHAPTER 13: Aggregate Demand,
Aggregate Supply, and Inflation
Let P equal the aggregate price level. Assuming
that G, T, and MS remain the same, the impact
of an increase in the price level on the
economy can be described as follows:
a.  P   M d   r   I   AE
b.  P   M d   r   I   AE
c.  P   M d   r   I   AE
d.  P   M d   r   I   AE
e.  P   M d   r   I   AE
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CHAPTER 13: Aggregate Demand,
Aggregate Supply, and Inflation
THE AGGREGATE DEMAND CURVE
THE AGGREGATE DEMAND CURVE: A WARNING
Aggregate demand falls when the price level increases because the higher price level
causes the demand for money (Md) to rise. With the money supply constant, the interest
rate will rise to reestablish equilibrium in the money market. It is the higher interest rate
that causes aggregate output to fall.
The AD curve is not the sum of all the market demand curves in the economy. It is not a
market demand curve.
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CHAPTER 13: Aggregate Demand,
Aggregate Supply, and Inflation
THE AGGREGATE DEMAND CURVE
OTHER REASONS FOR A DOWNWARD-SLOPING
AGGREGATE DEMAND CURVE
The Consumption Link
Planned investment does not bear all the burden of providing the link from a higher
interest rate to a lower level of aggregate output. Decreased consumption brought about
by a higher interest rate also contributes to this effect.
The Real Wealth Effect
real wealth, or real balance, effect The change
in consumption brought about by a change in real
wealth that results from a change in the price level.
An increase in the price level lowers the real value of some types of wealth.
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CHAPTER 13: Aggregate Demand,
Aggregate Supply, and Inflation
THE AGGREGATE DEMAND CURVE
AGGREGATE EXPENDITURE AND AGGREGATE
DEMAND
equilibrium condition: C + I + G = Y
At every point along the aggregate demand
curve, the aggregate quantity demanded is
exactly equal to planned aggregate
expenditure, C + I + G.
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CHAPTER 13: Aggregate Demand,
Aggregate Supply, and Inflation
Along the aggregate demand curve, each point
represents:
a. Equilibrium in the goods market, regardless of
the equilibrium situation in the money market.
b. Equilibrium in the money market, regardless
of the equilibrium situation in the goods
market.
c. Simultaneous equilibrium in both the goods
and money markets.
d. Macroeconomic equilibrium, or equilibrium in
all markets of the economy.
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CHAPTER 13: Aggregate Demand,
Aggregate Supply, and Inflation
Along the aggregate demand curve, each point
represents:
a. Equilibrium in the goods market, regardless of
the equilibrium situation in the money market.
b. Equilibrium in the money market, regardless
of the equilibrium situation in the goods
market.
c. Simultaneous equilibrium in both the
goods and money markets.
d. Macroeconomic equilibrium, or equilibrium in
all markets of the economy.
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CHAPTER 13: Aggregate Demand,
Aggregate Supply, and Inflation
THE AGGREGATE DEMAND CURVE
SHIFTS OF THE AGGREGATE DEMAND
An increase in the quantity of money supplied
at a given price level shifts the aggregate
demand curve to the right.
FIGURE 13.3 The Impact of an Increase in the
Money Supply on the AD Curve
An increase in government purchases or a
decrease in net taxes shifts the aggregate
demand curve to the right.
FIGURE 13.4 The Effect of an Increase in
Government Purchases or a Decrease in Net
Taxes on the AD Curve
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CHAPTER 13: Aggregate Demand,
Aggregate Supply, and Inflation
THE AGGREGATE DEMAND CURVE
SHIFTS OF THE AGGREGATE DEMAND
FIGURE 13.5 Factors That Shift the Aggregate Demand Curve
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CHAPTER 13: Aggregate Demand,
Aggregate Supply, and Inflation
Which of the following policy mixes consistently
shifts the aggregate demand curve to the
right?
a. Expansionary monetary policy accompanied
by contractionary fiscal policy.
b. Contractionary monetary policy accompanied
by contractionary fiscal policy.
c. Contractionary monetary policy accompanied
by expansionary fiscal policy.
d. Expansionary monetary policy accompanied
by expansionary fiscal policy.
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CHAPTER 13: Aggregate Demand,
Aggregate Supply, and Inflation
Which of the following policy mixes consistently
shifts the aggregate demand curve to the
right?
a. Expansionary monetary policy accompanied
by contractionary fiscal policy.
b. Contractionary monetary policy accompanied
by contractionary fiscal policy.
c. Contractionary monetary policy accompanied
by expansionary fiscal policy.
d. Expansionary monetary policy
accompanied by expansionary fiscal
policy.
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CHAPTER 13: Aggregate Demand,
Aggregate Supply, and Inflation
THE AGGREGATE SUPPLY CURVE
aggregate supply The total supply of all goods
and services in an economy.
THE AGGREGATE SUPPLY CURVE: A WARNING
aggregate supply (AS) curve A graph
that shows the relationship between the
aggregate quantity of output supplied by
all firms in an economy and the overall
price level.
An “aggregate supply curve” in the traditional sense of
the word supply does not exist. What does exist is what
we might call a “price/output response” curve—a curve
that traces out the price decisions and output decisions
of all the markets and firms in the economy under a
given set of circumstances.
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CHAPTER 13: Aggregate Demand,
Aggregate Supply, and Inflation
THE AGGREGATE SUPPLY CURVE
AGGREGATE SUPPLY IN THE SHORT RUN
Capacity Constraints
Even if firms are not holding excess labor
and capital, the economy may be operating
below its capacity if there is cyclical
unemployment.
Output Levels and Price/Output
Responses
FIGURE 13.6 The Short-Run Aggregate
Supply Curve
An increase in aggregate demand when the
economy is operating at low levels of output
is likely to result in an increase in output
with little or no increase in the overall price
level. That is, the aggregate supply
(price/output response) curve is likely to be
fairly flat at low levels of aggregate output.
When the economy is producing at its maximum level of output—that is, at capacity—
the aggregate supply curve becomes vertical.
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CHAPTER 13: Aggregate Demand,
Aggregate Supply, and Inflation
Which of the following factors affects the shape of
the AS curve?
a. Capacity constraints.
b. The price of output.
c. Cost shocks.
d. Economic growth.
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CHAPTER 13: Aggregate Demand,
Aggregate Supply, and Inflation
Which of the following factors affects the shape of
the AS curve?
a. Capacity constraints.
b. The price of output.
c. Cost shocks.
d. Economic growth.
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CHAPTER 13: Aggregate Demand,
Aggregate Supply, and Inflation
THE AGGREGATE SUPPLY CURVE
AGGREGATE SUPPLY IN THE SHORT RUN
The Response of Input Prices to Changes in the Overall
Price Level
If input prices changed at exactly the same rate as
output prices, the AS curve would be vertical.
Wage rates may increase at exactly the same rate as
the overall price level if the price level increase is fully
anticipated.
Input prices—particularly wage rates—tend to lag
behind increases in output prices for a variety of
reasons.
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CHAPTER 13: Aggregate Demand,
Aggregate Supply, and Inflation
If input prices changed at exactly the same rate
as output prices, then:
a. The aggregate demand curve would be
vertical.
b. The aggregate demand curve would be
horizontal.
c. The aggregate supply curve would be
vertical.
d. The aggregate supply curve would be
horizontal.
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CHAPTER 13: Aggregate Demand,
Aggregate Supply, and Inflation
If input prices changed at exactly the same rate
as output prices, then:
a. The aggregate demand curve would be
vertical.
b. The aggregate demand curve would be
horizontal.
c. The aggregate supply curve would be
vertical.
d. The aggregate supply curve would be
horizontal.
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CHAPTER 13: Aggregate Demand,
Aggregate Supply, and Inflation
THE AGGREGATE SUPPLY CURVE
SHIFTS OF THE AGGREGATE SUPPLY CURVE
cost shock, or supply shock A change in costs
that shifts the aggregate supply (AS) curve.
FIGURE 13.7 Shifts of the Aggregate Supply Curve
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CHAPTER 13: Aggregate Demand,
Aggregate Supply, and Inflation
THE AGGREGATE SUPPLY CURVE
SHIFTS OF THE AGGREGATE SUPPLY CURVE
FIGURE 13.8 Factors That Shift the Aggregate Supply Curve
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CHAPTER 13: Aggregate Demand,
Aggregate Supply, and Inflation
THE EQUILIBRIUM PRICE LEVEL
equilibrium price level The price level at
which the aggregate demand and aggregate
supply curves intersect.
FIGURE 13.9 The Equilibrium Price Level
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CHAPTER 13: Aggregate Demand,
Aggregate Supply, and Inflation
Refer to the graph below. At which point is Y = C + I + G?
a.
b.
c.
d.
At Y0, P0 only.
At every point along the AD curve.
At points corresponding to high price levels, such as (Y2,
P2).
At points corresponding to low price levels, such as (Y1, P1).
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CHAPTER 13: Aggregate Demand,
Aggregate Supply, and Inflation
Refer to the graph below. At which point is Y = C + I + G?
a.
b.
c.
d.
At Y0, P0 only.
At every point along the AD curve.
At points corresponding to high price levels, such as (Y2,
P2).
At points corresponding to low price levels, such as (Y1, P1).
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CHAPTER 13: Aggregate Demand,
Aggregate Supply, and Inflation
THE LONG-RUN AGGREGATE SUPPLY CURVE
If wage rates and other costs fully adjust to changes in prices in the long run, then the
long-run AS curve is vertical.
POTENTIAL GDP
potential output, or
potential GDP The
level of aggregate
output that can be
sustained in the long
run without inflation.
FIGURE 13.9 The Long-Run Aggregate Supply Curve
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CHAPTER 13: Aggregate Demand,
Aggregate Supply, and Inflation
AGGREGATE DEMAND, AGGREGATE SUPPLY,
AND MONETARY AND FISCAL POLICY
FIGURE 13.11 A Shift of the Aggregate
Demand Curve When the Economy
Is on the Nearly Flat Part of the AS Curve
FIGURE 13.12 A Shift of the Aggregate
Demand Curve When the Economy
Is Operating at or Near Maximum Capacity
LONG-RUN AGGREGATE SUPPLY AND POLICY EFFECTS
If the AS curve is vertical in the long run, neither monetary policy nor fiscal policy has
any effect on aggregate output in the long run.
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CHAPTER 13: Aggregate Demand,
Aggregate Supply, and Inflation
CAUSES OF INFLATION
INFLATION VERSUS SUSTAINED INFLATION: A REMINDER
inflation An increase in the overall price level.
sustained inflation Occurs when the overall price
level continues to rise over some fairly long period
of time.
DEMAND PULL INFLATION
demand-pull inflation Inflation that is initiated by
an increase in aggregate demand.
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CHAPTER 13: Aggregate Demand,
Aggregate Supply, and Inflation
Sustained inflation is:
a. A purely monetary phenomenon.
b. Strictly a situation of too many goods chasing
too few dollars.
c. Exclusively attributed to the pricing practices
of business firms.
d. Entirely the fault of contractionary fiscal policy
during periods of economic recession.
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CHAPTER 13: Aggregate Demand,
Aggregate Supply, and Inflation
Sustained inflation is:
a. A purely monetary phenomenon.
b. Strictly a situation of too many goods chasing
too few dollars.
c. Exclusively attributed to the pricing practices
of business firms.
d. Entirely the fault of contractionary fiscal policy
during periods of economic recession.
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CHAPTER 13: Aggregate Demand,
Aggregate Supply, and Inflation
CAUSES OF INFLATION
COST-PUSH, OR SUPPLY-SIDE, INFLATION
cost-push, or supplyside, inflation Inflation
caused by an increase
in costs.
FIGURE 13.13 Cost-Push, or Supply-Side, Inflation
stagflation Occurs when output is falling at the
same time that prices are rising.
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CHAPTER 13: Aggregate Demand,
Aggregate Supply, and Inflation
CAUSES OF INFLATION
EXPECTATIONS AND INFLATION
FIGURE 13.14 Cost Shocks Are Bad News for Policy Makers
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CHAPTER 13: Aggregate Demand,
Aggregate Supply, and Inflation
CAUSES OF INFLATION
MONEY AND INFLATION
hyperinflation A period
of very rapid increases in
the price level
FIGURE 13.15 Sustained Inflation from an Initial Increase in G and Fed Accommodation
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CHAPTER 13: Aggregate Demand,
Aggregate Supply, and Inflation
Which of the following scenarios leads to
hyperinflation?
a. Fed accommodation of expansionary fiscal
policy, while the economy is on the flat portion
of the AS curve.
b. Fed accommodation of expansionary fiscal
policy, while the economy is on the steep part
of the AS curve.
c. A decrease in the money supply when the
economy finds itself on the flat portion of the
AS curve.
d. A decrease in the money supply when the
economy finds itself on the steep portion of
the AS curve.
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CHAPTER 13: Aggregate Demand,
Aggregate Supply, and Inflation
Which of the following scenarios leads to
hyperinflation?
a. Fed accommodation of expansionary fiscal
policy, while the economy is on the flat portion
of the AS curve.
b. Fed accommodation of expansionary
fiscal policy, while the economy is on the
steep part of the AS curve.
c. A decrease in the money supply when the
economy finds itself on the flat portion of the
AS curve.
d. A decrease in the money supply when the
economy finds itself on the steep portion of
the AS curve.
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CHAPTER 13: Aggregate Demand,
Aggregate Supply, and Inflation
REVIEW TERMS AND CONCEPTS
aggregate demand
aggregate demand (AD)
curve
aggregate supply
aggregate supply (AS)
curve
cost-push, or supply-side,
inflation
cost shock, or supply shock
demand-pull inflation
equilibrium price level
hyperinflation
inflation
inflationary gap
potential output, or potential
GDP
real wealth, or real balance,
effect
stagflation
sustained inflation
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