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Aggregate Demand and Aggregate Supply

January 12, 2011. Aggregate Demand and Aggregate Supply. Aggregate Demand. Amount of real GDP purchased at each price level Why the downward slope? Real-balances effect Interest-rate effect Foreign purchases effect Consumption, investment, and net exports. Aggregate Demand Curve.

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Aggregate Demand and Aggregate Supply

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  1. January 12, 2011 Aggregate Demand and Aggregate Supply

  2. Aggregate Demand • Amount of real GDP purchased at each price level • Why the downward slope? • Real-balances effect • Interest-rate effect • Foreign purchases effect • Consumption, investment, and net exports

  3. Aggregate Demand Curve Aggregate Demand Price Level AD Real Domestic Output, GDP

  4. Aggregate Demand • Determinants of aggregate demand • Fixed variables along the demand curve • Change in fixed variable • Multiplier effect • Consumer spending variables: • Consumer wealth • Consumer expectations • Household borrowing • Personal taxes

  5. Aggregate Demand • Investment spending variables • Real interest rates • Expected returns • Future business conditions • Technology • Degree of excess capacity • Business taxes

  6. Aggregate Demand • Government spending • Net export spending variables • National income abroad • Exchange rates

  7. Changes in Aggregate Demand Increase in Aggregate Demand Price Level Decrease in Aggregate Demand AD2 AD1 AD3 Real Domestic Output, GDP

  8. Aggregate Supply • Amount real GDP produced at each price level • Three time horizons • Immediate short run • Few days to a few months • All prices fixed • Implicit price agreements • Contractual agreements

  9. Aggregate Supply ASISR Price Level Immediate-short-run Aggregate Supply Qf Real Domestic Output, GDP

  10. Aggregate Supply • Short run • Input prices fixed • Output prices variable • Real profit changes • Long run • All prices variable • Full employment GDP • All prices adjust

  11. Aggregate Supply Slope not constant: per unit production cost and firm capacity Aggregate Supply (Short Run) Price Level 0 Qf Real Domestic Output, GDP

  12. Aggregate Supply ASLR Price Level Long-run Aggregate Supply Qf Real Domestic Output, GDP

  13. Aggregate Supply • Determinants of aggregate supply • Change in input price • Domestic resource prices • Prices of imported resources • Change in productivity • Change in legal-institutional environment • Business taxes and subsidies • Government regulation

  14. Aggregate Supply AS3 Decrease in Aggregate Supply AS1 AS2 Price Level Increase in Aggregate Supply Real Domestic Output, GDP

  15. Equilibrium Real Output Demanded (Billions) Real Output Supplied (Billions) Price Level (Index Number) $506 508 510 512 514 108 104 100 96 92 $513 512 510 507 502 Equilibrium Price Level and Equilibrium Real GDP

  16. Equilibrium AS Price Level Equilibrium 100 92 b a AD 502 510 514 Real Domestic Output, GDP (Billions of Dollars)

  17. Changes in Equilibrium Increase in Aggregate Demand AS Demand-Pull Inflation P2 Price Level P1 AD1 AD Qf Q1 Q2 Real Domestic Output, GDP

  18. Changes in Equilibrium Decrease in Aggregate Demand AS Price Level b a P1 c P2 Creates a Recession AD1 AD2 Q1 Q2 Qf Real Domestic Output, GDP

  19. Changes in Equilibrium • Decrease in aggregate demand • Recession and cyclical unemployment • Deflation? • Downward price inflexibility: • Fear of price wars • Menu costs • Wage contracts • Morale, effort, and productivity • Efficiency wages • Minimum Wage

  20. Changes in Equilibrium Decrease in Aggregate Supply AS2 AS1 Cost-Push Inflation b P2 Price Level a P1 AD Q1 Qf Real Domestic Output, GDP

  21. Changes in Equilibrium Increases in Aggregate Supply – Full-Employment With Price-Level Stability AS1 AS2 P3 b c P2 a P1 Price Level AD2 AD1 Q1 Q2 Q3 Real Domestic Output, GDP

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