Download Aggregate Supply

I. AD/AS Model
• To Analyze changes in real GDP & price level
simultaneously
• Provides insights on inflation, unemployment, &
economic growth
• Aggregate Demand
– Amounts of real output
– Buyers collectively desire
– At each possible price level
• Aggregate Supply
– Levels of real domestic output firms will produce
– At each possible price level
II. Aggregate Demand Curve
• Income & substitution effects do not apply
• AD Curve – negative slope
– Real-Balances effect
• Higher price level means real value of savings
decreases
• Thus lowering consumption
– Interest-rate effect
• High demand for $ leads to high interest rates
• High interest rates limit investment spending
• Thus leads to less real output
– Foreign purchases effect
• US price level up then foreigners buy less US
goods
Price level
AGGREGATE DEMAND CURVE
AD
Real domestic output, GDP
CHANGES IN AGGREGATE DEMAND
Price level
Aggregate Demand
Can Increase
AD2
AD1
Real domestic output, GDP
Price level
CHANGES IN AGGREGATE DEMAND
Aggregate Demand
Can Increase
…or Decrease
AD3
AD1
Real domestic output, GDP
Determinants of AD
• Change in consumer spending (C)
–
–
–
–
Wealth effect
Consumer expectations
Household indebtedness
Personal income taxes
• Change in investment spending (Ig)
– Real interest rates
– Expected returns
•
•
•
•
Future business conditions
Technology
Degree of excess capacity
Business taxes
• Change in government spending (G)
• Net export spending (Xn)
– National income abroad
– Exchange rates
III. Aggregate Supply
• Long-run AS curve
– Vertical at full-employment level of real
GDP
– Resource prices adjust to changes in PL – no
incentive for firms to change output
• Short-run AS curve
– Upward sloping
– Rise in price level increases real output
– Lag between product prices & resource prices
make it profitable for firms to increase output
when PL rises
AGGREGATE SUPPLY
Price level
Short Run
AS
Aggregate
Supply
Short-run
FullEmployment
Qf
Real domestic output, GDP
AGGREGATE SUPPLY
Changes in Aggregate Supply
AS3
Price level
AS1
Decrease In
Aggregate
Supply
AS2
Increase In
Aggregate
Supply
Real GDP
AGGREGATE SUPPLY
Long Run
Price level
ASLR
Long-run
Aggregate
Supply
Full-Employment
Qf
Real GDP
AS - amount of real output firms will produce at each PL.
Higher price levels provide an incentive to produce more.
AS has three ranges:
AS
Price level
1. Horizontal
(Keynesian)
2. Intermediate
3. Vertical
(Classical)
Horizontal
Vertical
[Classical]
Range
[Keynesian]
Range
Upsloping or
Intermediate
Range
Q
Real domestic output, GDP
IV. Determinants of AS
• Input prices
– Domestic
• Land
• Labor
• Capital
– Prices of imported resources
– Market power (OPEC)
• Productivity = Total output/total inputs
• Legal-institutional environment
– Business taxes and subsidies
– Government regulation
EQUILIBRIUM AND CHANGES
IN EQUILIBRIUM
Price Level
P
100
92
AS
a
b
Equilibrium
Real Output
AD
Q
Real Domestic Output, GDP
INCREASES IN AD:
DEMAND-PULL INFLATION
Price Level
P
AD1
AD2
AS
P2
P1
Qf
Q 1 Q2
Real Domestic Output, GDP
Q
[“Good News” – more jobs; “Bad News” – higher prices]
DECREASES IN AD: RECESSION
& CYCLICAL UNEMPLOYMENT
Price Level
P
P1
AD2
AD1
b
AS
a
c
Q1
Qf
Q
Real Domestic Output, GDP
[“Good News”–lower prices; “Bad News”–job losses]
DECREASES IN AS:
COST-PUSH INFLATION
AS2
Price Level
P
P2
P1
AS1
b
a
AD1
Q1 Qf
Real Domestic Output, GDP
Q
[“bad news” – job losses; “bad news” – inflation]
V. “Sticky Prices” – prices
inflexible (rigid) in a downward
direction
•
•
•
•
•
Wage Prices
Morale, effort, productivity
Minimum wage
Menu costs
Fear of price wars
Consumption
Investment
Gov. Spending
Exports
Injections
Full Employment
[Frictional & structural]
Income
Employment
Output
Saving
Taxes
Imports
*Classicals – “A leakage down
the drain of saving is returned
thru the spigot of investment.”
Leakages
An economy in equilibrium at FE
Review of the Marginal Propensities
1. If consumption increases from 465 to
480 and disposable income increases
from 490 to 510. What is the marginal
propensity to consume? 15/20 = .75
2. If the marginal propensity to consume is
0.8 then what is the marginal
propensity to save? MPS = 0.2
3. Why will the MPC + MPS always equal
Consuming or saving is an either-or proposition
1?
Aggregate Expenditures
Model
Building
[Simple [Basic] economy to Complex economy]
[C + Ig]
Private-closed
Private - closed
[C + Ig + Xn] Private-open
[C+Ig+G+Xn]
Private-open
Mixed - open Mixed-open
(AE3)630
(AE2)550
(AE1)470
Consumption
C=390
+80 +80 +80
45°
0 390 470 550 630 Real GDP
“Mult” = 4
AE(C+Ig+G)
AE3 (C+Ig+G+Xn) (Complex Economy) [Mixed-open]
AE2 (C+Ig+Xn) (Private-open) [X(40)-M(20)]
AE1(C+Ig)[Basic Economy][Private(no G)-Closed(no X or M)]
AE(C+Ig+G)
AE(C+Ig1)
45°
460
YR
500 Real GDP
Y*
I. AE Model / Keynesian Cross
Model
• Aggregate Expenditures means total
spending
• When AE fall – Total output & employment
decrease
• When AE rise – Total output &
employment increase
II. Mixed Economy
• AE = C + Ig + G + Xn
• Increase in public spending shifts AE upward & produces
higher equilibrium GDP
• In a mixed economy the Savings (Leakages) = planned
investment (Injections)
– Sa + M + T = Ig + X + G
• Lump-sum tax (constant at each level of GDP) –
Reduces C & S
• Proposed balanced budget requirement (G spending = G
revenue) would eliminate discretionary fiscal policy
• Balance budget multiplier = 1 (equal increases in G &
T) AE shift is equal to change in G or T
FULL-EMPLOYMENT GDP
Aggregate Expenditures (billions of dollars)
Recessionary Gap
AE0
AE1
530
510
Recessionary Gap
= $5 Billion
490
Full Employment
o
45
o
490
510
530
Real domestic product, GDP (billions of dollars)
FULL-EMPLOYMENT GDP
Aggregate Expenditures (billions of dollars)
Inflationary Gap
530
AE2
AE0
Inflationary Gap
= $5 Billion
510
490
Full Employment
o
45
o
490
510
530
Real domestic product, GDP (billions of dollars)
III. Limitations
• No price-level changes
• Ignores premature demand-pull inflation
• Limits real GDP to the full-employment
level of output
• Ignores cost-push inflation
• Does not allow for self-correction