1 / 13

Macro Theory:

Macro Theory:. Dr. D. Foster – ECO 285 – Spring 2014. The AS/AD Model. Warning .. Warning .. Warning. Aggregate Supply and Aggregate Demand are not like market supply & demand !!!!! The “static” analysis only hints at dynamic interpretation.

ryo
Download Presentation

Macro Theory:

An Image/Link below is provided (as is) to download presentation Download Policy: Content on the Website is provided to you AS IS for your information and personal use and may not be sold / licensed / shared on other websites without getting consent from its author. Content is provided to you AS IS for your information and personal use only. Download presentation by click this link. While downloading, if for some reason you are not able to download a presentation, the publisher may have deleted the file from their server. During download, if you can't get a presentation, the file might be deleted by the publisher.

E N D

Presentation Transcript


  1. Macro Theory: Dr. D. Foster – ECO 285 – Spring 2014 The AS/AD Model

  2. Warning .. Warning .. Warning • Aggregate Supply and Aggregate Demand are not like market supply & demand !!!!! • The “static” analysis only hints at dynamic interpretation. • Ceteris Paribus assumption problematic to the point of being wholly inappropriate. • Keynesian model notes: • Descriptive analysis. • Some numerical interpretation. • Only AS/AD graphical representation.

  3. The Aggregate Demand Schedule P P = Price Level; CPI or GDP deflator Q = real output;Real GDP AD = Agg. Demand; From 4 sectors – HH, Bus, G, Foreign A P2 B P1 AD1 Q or R-GDP Q1 Q2

  4. Aggregate Demand • The price level and real output demanded are inversely related. • A fall in the price level will increase quantity demanded. • Why? -- the Wealth Effect • All prices and wages change. • But, the fixed wealth is … well, still fixed! • So, with lower prices we feel wealthier. Woo Hoo! • And, so we want to buy more stuff.

  5. Aggregate Demand • What about: • Interest effect • Foreign trade effect • Exchange rate effect Can’t do “all else equal.” e.g. Lower price: Exports Imports and seemingly  quantity demanded. But, this S€ and D€ which will reduce our exports, increase imports. • AD can shift to the left or right. • Increase AD – shift to the right. • Decrease AD – shift to the left. • Whenever C, I, G, net X increase/decrease. • Why? Due to changes in the money supply … later.

  6. AD2 The Aggregate Demand Schedule P Increases in C, I, G, net X AD3 Decreases in C, I, G, net X AD1 Q or R-GDP

  7. Long Run Equilibrium betweenAggregate Demand and Aggregate Supply • There is an Aggregate Supply that reflects fully employed resource use. • Output level:Q* or RGDP* or potential RGDP P AS1 • Shifts in AD can only change the price level and not real output (nor employment). Classical Model of the Economy P1 AD1 Q or R-GDP

  8. What affects the Aggregate Supply? • Labor force participation. • Labor productivity. • Marginal tax rates on wages. • Provision of government benefits that affect household incentives w.r.t. supply labor. • State of technology. • Capital stock. A change in these factors can AS (shift right)or AS (shift left)

  9. Short Run Aggregate Supply – Wage Inflexibility • Nominal wages are sluggish upwards: • A rise in prices has delayed effect on wages. • Nominal wages are inflexible downwards: • A fall in prices will result in employment and Q. • Workers have money illusion: • Higher nominal wages are viewed as real wage. • So, more workers available even though real wage has not risen. • e.g. if prices rise 5% and wages rise 3%…

  10. Short Run Aggregate Supply • The Short Run will adjust to the Long Run: • An AD will P and Q, but only in the SR. • Prices rise but wages lag. Firms employment and output. • Eventually, workers realize their real wages (W/P) are falling, get comparable wage, AS. • The temporary profit motive has been eliminated. • What about: • Sticky prices • Misperception • Intertemporal substitution Unnecessary complicationsto explain the SR AS.Inflexible wages is all we need. What happens if there is a AD?

  11. From SR to LR Aggregate Supply An increase in AD triggers events. AS3 P ASLR AS2 AS1 Prices rise, wages lag, output rises. Eventually, wages catch up and AS declines. In LR, onlyprices rise. P3 P2 P1 AD2 AD1 Q or R-GDP Q2 Q*

  12. From SR to LR Aggregate Supply From the new equilibrium, what happens if AD falls? AS3 P ASLR AS4 Prices fall, wages lag, output falls. Eventually, wages catch up and AS rises. In LR, onlyprices fall. P3 P2 P1 AD2 AD3 Q or R-GDP Q3 Q*

  13. Macro Theory: Dr. D. Foster – ECO 285 – Spring 2014 The AS/AD Model

More Related