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Aim: What is Macroeconomics and AD? Roots of Macroeconomics • The Great Depression • Classical economists believed that the economy was self correcting • Keynes believes that aggregate demand determines unemployment, not price and wages Recent Macroeconomic History • Fine Tuning: 1960s • Disillusionment – Recessions: 1974-1975, 1980-1981 – High Inflation: 1974-1975 & 1979-1981 – Moderate Recession 1990-1991 – Stagflation – overall price level rising during recessionary periods • Good Times: 1990s into next century Macroeconomic Concerns • Aggregate price level – inflation • Aggregate output – production of goods and services • Total Employment • International economy’s relationship to the domestic economy The Role of Government in the Macro economy • Fiscal Policy • Monetary Policy • Income Policies – direct attempt by the govt to control prices and wages • Supply-Side Policies – use tax system to increase production – trickle down economics Components of Aggregate Demand • Measures the relationship between spending & income: components of spending which make up the AD model are consumption, investment and savings • The AD reflects the changes in demand when the price level for all goods and services increases or decreases • When the general price level increases we do not substitute one good for another, rather we as a nation buy less goods and services • The substitutes in this case are money financial assets, good and services in the future and imports. • Economists identify three primary effects that increase real GDP when the price level decreases and decrease real GDP when the price level increases. These effects explain why a given AD curve has a negative slope: – Real Wealth or Real Balance Effect – Foreign Trade Effect – Interest Rate Effect AD curve shifts right when • Consumption increases as a result from – Expectations of inflation or shortages in the future – Increased incomes or wealth – Optimism about jobs and income • Investment increases when – Interest rates drop – Investors gain optimism • Government carries out expansionary policy such as – Increase in spending – Increase in the money supply – Decrease in taxes • Net exports increase when – Exchange rate decreases (imports decrease) – Foreign income increases (exports decrease) Aggregate Supply • indicates the total value of output producers are willing and able to supply at alternative price levels in a given period • Short-Run AS – flat depression range, a positively sloped intermediate range, and a vertical physical limit – horizontal range: large inventories and excess capacity, suppliers would be happy to sell more output at the existing price level, workers are plentiful & the economy can increase output without placing upward pressure on prices or wages – intermediate range: positive slope, normal range of operation, no excess inventories, gives firms the incentive they need to increase employment and produce more goods and services –vertical range: when factories cannot run any faster and workers cannot work any more overtime – the economy has reached its physical limit for output, the economy reaches full employment • Long-Run AS – no cyclical unemployment, increases of output do not place upward pressure on wages and other input prices AS curve shifts right when • Inputs become cheaper, more productive or more plentiful as with – new discoveries of raw materials – increases in the labor supply – decreases in wages or other input prices – improvements in education or training – decreased inflationary expectations – increased investment – more capital – technological advances • Government policies reduce production costs as with – tax cuts – deregulation – reform in welfare or unemployment insurance programs • Weather is good and or macro disturbances cease such as – wars – natural disasters