Download Aggregate Supply and Demand

Aggregate Demand
Quantity
Demanded
Demand
The Model of Aggregate Demand
and Aggregate Supply
P
The price
level
The model
determines the
eq’m price level
SRAS
P1
“Aggregate
Demand”
and eq’m output
(real GDP).
AGGREGATE DEMAND
AND AGGREGATE
SUPPLY
Y1
3
“Short-Run
Aggregate
Supply”
AD
Y
Real GDP, the
quantity of output
The Aggregate-Demand (AD) Curve
The AD curve
shows the
quantity of
all goods and
services
demanded
in the economy at
any given price
level.
P
P2
P1
AD
Y2
AGGREGATE DEMAND
AND AGGREGATE
SUPPLY
4
Y1
Y
Why the AD Curve Slopes Downward
P
Y = C + I + G + NX
Assume G fixed
by govt policy.
To understand
the slope of AD,
must determine
how a change in P
affects C, I, and NX.
P2
P1
AD
Y2
AGGREGATE DEMAND
AND AGGREGATE
SUPPLY
5
Y1
Y
The Wealth Effect (P and C )
Suppose P rises.
0 The dollars people hold buy fewer g&s,
so real wealth is lower.
0 People feel poorer.
Result: C falls.
AGGREGATE DEMAND
AND AGGREGATE
SUPPLY
6
The Interest-Rate Effect (P and I )
Suppose P rises.
0 Buying g&s requires more dollars.
0 To get these dollars, people sell bonds or other assets.
0 This drives up interest rates.
Result: I falls.
(Recall, I depends negatively on interest rates.)
AGGREGATE DEMAND
AND AGGREGATE
SUPPLY
7
The Exchange-Rate Effect (P and NX )
Suppose P rises.
0 U.S. interest rates rise (the interest-rate effect).
0 Foreign investors desire more U.S. bonds.
0 Higher demand for $ in foreign exchange market.
0 U.S. exchange rate appreciates.
0 U.S. exports more expensive to people abroad, imports
cheaper to U.S. residents.
Result: NX falls.
AGGREGATE DEMAND
AND AGGREGATE
SUPPLY
8
The Slope of the AD Curve: Summary
An increase in P
reduces the quantity
of g&s demanded
because:
P
P2
 the wealth effect
(C falls)
 the interest-rate
P1
AD
effect (I falls)
 the exchange-rate
Y2
effect (NX falls)
AGGREGATE DEMAND
AND AGGREGATE
SUPPLY
9
Y1
Y
Why the AD Curve Might Shift
Any event that changes C,
I, G, or NX
– except a change in P –
will shift the AD curve.
Example:
A stock market boom
makes households feel
wealthier, C rises,
the AD curve shifts right.
P
P1
AD1
Y1
AGGREGATE DEMAND
AND AGGREGATE
SUPPLY
10
Y2
AD2
Y
Why the AD Curve Might Shift
0 Changes in C
0 Stock market boom/crash
0 Preferences: consumption/saving tradeoff
0 Tax hikes/cuts
0 Changes in I
0 Firms buy new computers, equipment, factories
0 Expectations, optimism/pessimism
0 Interest rates, monetary policy
0 Investment tax credit or other tax incentives
AGGREGATE DEMAND
AND AGGREGATE
SUPPLY
11
Why the AD Curve Might Shift
0 Changes in G
0 Federal spending, e.g., defense
0 State & local spending, e.g., roads, schools
0 Changes in NX
0 Booms/recessions in countries that buy our exports.
0 Appreciation/depreciation resulting from international
speculation in foreign exchange market
AGGREGATE DEMAND
AND AGGREGATE
SUPPLY
12
The Aggregate-Supply (AS) Curves
The AS curve shows
the total quantity of
g&s firms produce and
sell at any given price
level.
P
LRAS
SRAS
AS is:
 upward-sloping
in short run…why?
Y
 vertical in long
run…why?
AGGREGATE DEMAND
AND AGGREGATE
SUPPLY
14
The Long-Run Aggregate-Supply Curve (LRAS)
The natural rate of
output (YN) is the
amount of output
the economy produces
when unemployment
is at its natural rate.
P
LRAS
YN is also called
potential output
or
full-employment
output.
AGGREGATE DEMAND
AND AGGREGATE
SUPPLY
YN
15
Y
Why LRAS Is Vertical
YN determined by the
P
economy’s stocks of
labor, capital, and
natural resources, and
P2
on the level of
technology.
An increase in P
LRAS
P1
does not affect
any of these,
so it does not
affect YN.
AGGREGATE DEMAND
AND AGGREGATE
SUPPLY
YN
16
Y
Why the LRAS Curve Might Shift?
0 Labor
0 Capital
0 Resources
0 Technology
AGGREGATE DEMAND
AND AGGREGATE
SUPPLY
17
Short Run Aggregate Supply (SRAS)
The SRAS curve
is upward sloping:
Over the period
of 1-2 years,
an increase in P
causes an
increase in the
quantity of g & s
supplied.
P
SRAS
P2
P1
Y1
AGGREGATE DEMAND
AND AGGREGATE
SUPPLY
18
Y2
Y
Why the Slope of SRAS Matters
If AS is vertical,
fluctuations in AD
do not cause
fluctuations in output
or employment.
If AS slopes up,
then shifts in AD
do affect output
and employment.
AGGREGATE DEMAND
AND AGGREGATE
SUPPLY
LRAS
P
Phi
SRAS
Phi
ADhi
Plo
AD1
Plo
ADlo
Ylo
19
Y1
Yhi
Y
Three Theories of SRAS
Sticky Wages
Sticky Prices
Misperceptions
AGGREGATE DEMAND
AND AGGREGATE
SUPPLY
20
Economic Fluctuations
0 Caused by events that shift the AD and/or
AS curves.
0 Four steps to analyzing economic fluctuations:
1. Determine whether the event shifts AD or AS.
2. Determine whether curve shifts left or right.
3. Use AD-AS diagram to see how the shift changes Y and P in
the short run.
4. Use AD-AS diagram to see how economy
moves from new SR eq’m to new LR eq’m.
AGGREGATE DEMAND
AND AGGREGATE
SUPPLY
21
The Effects of a Shift in AD
Event: Stock market crash
1. Affects C, AD curve
P
LRAS
2. C falls, so AD shifts left
3. SR eq’m at B.
P and Y lower,
unemp higher
4. Over time, PE falls,
SRAS shifts right,
until LR eq’m at C.
Y and unemp back
at initial levels.
AGGREGATE DEMAND
AND AGGREGATE
SUPPLY
SRAS1
A
P1
P2
SRAS2
B
P3
AD1
C
AD2
Y2
22
YN
Y