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Chapter 23:
Output and Prices
in the Short Run
Copyright © 2014 Pearson Canada Inc.
Chapter Outline/Learning Objectives
Section
Learning Objectives
After studying this chapter, you will be able to
23.1 The Demand Side
of the Economy
1.
explain why an exogenous change in the price level
shifts the AE curve and changes the equilibrium level
of real GDP.
2.
derive the aggregate demand (AD) curve and
understand what causes it to shift.
23.2 The Supply Side
of the Economy
3.
describe the meaning of the aggregate supply (AS)
curve and understand why it shifts when technology
or factor prices change.
23.3 Macroeconomic
Equilibrium
4.
explain how AD and AS shocks affect equilibrium real
GDP and the price level.
Copyright © 2014 Pearson Canada Inc.
Chapter 23, Slide 2
23.1 The Demand Side of the Economy
Exogenous Changes in the Price Level
An increase in P reduces the real value of money holdings.
A fall in P raises the real value of money holdings.
Changes in P also affect the wealth of bondholders and bond issuers
• but there is no change in aggregate wealth*
*Only if bonds are not held by foreigners.
Copyright © 2014 Pearson Canada Inc.
Chapter 23, Slide 3
Exogenous Changes in the Price Level
An increase in P thus reduces private-sector wealth:
• reduction in desired consumption
• downward shift in AE curve
There is also an effect on net exports:
• the NX function shifts downward
• further downward shift in AE curve
Conversely for a fall in P.
Copyright © 2014 Pearson Canada Inc.
Chapter 23, Slide 4
Fig. 23-1
Desired Aggregate Expenditure and the Price Level
An increase in P
reduces desired
aggregate expenditure:
AE shifts down,
equilibrium Y falls.
Copyright © 2014 Pearson Canada Inc.
Chapter 23, Slide 5
The Aggregate Demand Curve
The aggregate demand (AD) curve relates equilibrium real GDP to
the price level.
For any given P, the AD curve shows the level of real GDP for which
desired aggregate expenditure equals actual GDP.
Changes in the price level cause movements along the AD curve.
Copyright © 2014 Pearson Canada Inc.
Chapter 23, Slide 6
Fig. 23-2
Derivation of the AD Curve
Consider a rise in the
price level, from P0 to P2:
The AE curve shifts down,
but we move along the
AD curve.
(i) Aggregate expenditure
(ii) Aggregate demand
Copyright © 2014 Pearson Canada Inc.
Chapter 23, Slide 7
Fig. 23-3
The Simple Multiplier and Shifts in the AD Curve
Shifts in the AD Curve
(aggregate demand shocks)
Any shock that increases
equilibrium GDP at a
given price level shifts
the AD curve to the right.
(i) Aggregate expenditure
The horizontal shift of
the AD curve is the simple
multiplier times the change
in autonomous spending.
(ii) Aggregate demand
Copyright © 2014 Pearson Canada Inc.
Chapter 23, Slide 8
Determinants of Aggregate Demand (I)
1.
2.
3.
Consumption
– Changes in wealth, age of consumer durables and
consumer expectations will change aggregate demand
Investment
– Changes in interest rates, age of capital goods,
business expectations and government policies will
change aggregate demand
Net exports
– Change in the value of exchange rate, income levels
abroad and price of competitive foreign goods
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Determinants of AD (II)
3.
4.
5.
Government spending
– Amount of spending on goods, services, or
transfer payments to households or firms
Tax rates
Money supply
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23.2 The Supply Side of the Economy
The Aggregate Supply Curve
The AS curve relates the price level to the quantity of output that
firms would like to produce and sell.
The AS curve is drawn for a given:
• level of technology
• set of factor prices
As unit costs rise with output, firms will produce more output only
if prices increase:
 AS curve is upward sloping
Copyright © 2014 Pearson Canada Inc.
Chapter 23, Slide11
The Aggregate Supply Curve
The slope of the AS curve is increasing as output rises:
• when output is low, firms typically have excess capacity
 costs do not rise quickly
• when output is nearer Y*, costs rise as output rises
 firms need higher prices
EXTENSIONS IN THEORY 23-1
The Keynesian AS Curve
Copyright © 2014 Pearson Canada Inc.
Chapter 23, Slide 12
Shifts in Aggregate Supply Curve
Aggregate Supply Shocks
Fig. 23-5
Shifts in the AS Curve
Anything that increases
firms' costs causes the
AS curve to shift up:
• factor prices
• technology
Copyright © 2014 Pearson Canada Inc.
Chapter 23, Slide 13
23.3 Macroeconomic Equilibrium
Demand behaviour is
consistent with supply
behaviour only at the
intersection of the
two curves.
Fig. 23-6
Macroeconomic Equilibrium
E0 is the macroeconomic
equilibrium.
Copyright © 2014 Pearson Canada Inc.
Chapter 23, Slide 14
Determinants of Aggregate Supply
An increase in AS will result from:
1. A decrease in factor prices
2. Technological improvement
3. An improvement in human capital
4. An increase in the amount of capital
5. An increase in natural resources
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Changes in Macroeconomic Equilibrium
Demand shocks can either be expansionary or contractionary.
• direction of AD shift
Supply shocks can either be expansionary or contractionary.
• direction of the AS shift
In both cases, "expansionary" or "contractionary" refers to
the effect on equilibrium output.
Copyright © 2014 Pearson Canada Inc.
Chapter 23, Slide 16
Aggregate Demand Shocks
Demand shocks cause
P and Y to change in
the same direction.
Fig. 23-7
Aggregate Demand Shocks
Possible causes:
• ΔG > 0
• ΔI > 0
• ΔX > 0
• ΔC > 0
Copyright © 2014 Pearson Canada Inc.
Chapter 23, Slide 17
Fig. 23-8
The Multiplier When the Price Level Varies
The Mechanics of an AD Shift
The shock causes the AE
curve to shift upward, but
the rise in the price level
causes it to shift down.
With an upward sloping AS
curve, the multiplier is
smaller than the simple
multiplier.
(i) Aggregate expenditure
(ii) Aggregate demand
Copyright © 2014 Pearson Canada Inc.
Chapter 23, Slide 18
Fig. 23-9
The Effects of Increases in Aggregate Demand
The effect of any given
shift of the AD curve will
depend on the slope of
the AS curve.
The steeper the AS curve,
the greater the price effect
and the smaller the output
effect.
Copyright © 2014 Pearson Canada Inc.
Chapter 23, Slide 19
Aggregate Supply Shocks
Fig. 23-10 A Negative
Aggregate Supply Shock
Aggregate supply shocks
cause P and Y to change
in opposite directions.
(i) Aggregate expenditure
Possible causes:
• Δ price of inputs
• Δ wages
• Δ technology
Copyright © 2014 Pearson Canada Inc.
(ii) Aggregate demand and supply
Chapter 23, Slide 20
A Word of Warning
Many economic events (especially changes in the world prices
of raw materials) cause both aggregate demand and aggregate
supply shocks.
The overall effect on the economy depends on the relative
importance of the two separate effects.
LESSONS FROM HISTORY 23-1
The Asian Crisis and the Canadian Economy
Copyright © 2014 Pearson Canada Inc.
Chapter 23, Slide 21
Review
1. Which of the following will cause a positive aggregate supply
shock?
A) an increase in the price of raw materials
B) a decrease in productivity
C) a decrease in the price of oil
D) a decrease in the price of foreign output
E) an increase in the price of foreign output
© 2014 Pearson Education Canada Inc.
22
Review
Refer to Figure on the left. Suppose
that an increase in government
purchases by 50 causes the AD curve
to shift to the right, as shown. The
simple multiplier is ________ and
the multiplier is ________.
A) 4; 3.2
B) 4; 1.2
C) 2.8; 1.2
D) 4; 2.8
E) 6; 1.2
© 2014 Pearson Education Canada Inc.
23
Review
Suppose firms are currently producing beyond their normal capacity.
A change in AD leads to a relatively
A) small change in price level and a small change in real GDP.
B) no change in both price and output.
C) large change in price level and a large change in real GDP.
D) large change in price level and a small change in real GDP.
E) small change in price level and a large change in real GDP.
© 2014 Pearson Education Canada Inc.
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