1 / 73

Chapter 22

Chapter 22. Aggregate Demand and Supply Analysis. A ggregate D emand. Aggregate demand is made up of four component parts: C = consumption expenditure , the total demand for consumer goods and services

wanda
Download Presentation

Chapter 22

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. Chapter 22 Aggregate Demand and Supply Analysis

  2. Aggregate Demand • Aggregate demand is made up of four component parts: • C= consumption expenditure, the total demand for consumer goods and services • I = planned investment spending, the total planned spending by business firms on new machines, factories, and other capital goods, plus planned spending on new homes • G = government purchases , spending by all levels of government (federal, state, and local) on goods and services • NX = net exports, the net foreign spending on domestic goods and services

  3. Aggregate Demand • The Quantity Theory of Money (QTM) implies the aggregate demand curve is downward sloping. • The QTM results when velocity is assumed to be constant in the equation of exchange: • A constant money supply implies constant nominal aggregate spending • A decrease in the price level is matched with an increase in real GDP. • Recall that inflation is defined as follows: • Hence, a rise in real GDP is associated with a decline in PLis, which causes p to fall for a given value of PLwas.

  4. Aggregate Demand QTM: • The quantity of real GDP demanded decreases in p. p AD Y

  5. Aggregate Demand QTM: • The quantity of real GDP demanded decreases in p. • AD increases when • increases • increases • increases • is increased • is cut • decreases • Financial frictiondecreases p AD Y

  6. Aggregate Demand Aggregate Demand

  7. Aggregate Demand Aggregate Demand • The Congress and President are in charge of fiscal policy. Expansionary fiscal policy involves a cut in T and/or increase in G Restrictive fiscal policy involves a raising T and/or cutting G • The Federal Reserve (our central bank) is in charge of monetary policy Expansionary monetary policy involves lowering the federal funds interest rate Restrictive monetary policy involves raising the federal funds interest rate

  8. Aggregate Demand Aggregate Demand • The Congress and President are in charge of fiscal policy. • Expansionary fiscal policy involves a cut in T and/or increase in G Restrictive fiscal policy involves a raising T and/or cutting G • The Federal Reserve (our central bank) is in charge of monetary policy • Expansionary monetary policy involves lowering the federal funds interest rate Restrictive monetary policy involves raising the federal funds interest rate

  9. Aggregate Demand Aggregate Demand • The Congress and President are in charge of fiscal policy. • Expansionary fiscal policy involves a cut in T and/or increase in G • Restrictive fiscal policy involves a raising T and/or cutting G • The Federal Reserve (our central bank) is in charge of monetary policy • Expansionary monetary policy involves lowering the federal funds interest rate • Restrictive monetary policy involves raising the federal funds interest rate

  10. Long Run Aggregate Supply The Economy’s Production Function • Example: Suppose the economy’s production function shows the volume of output that can be produced by its labor force of size L given levels of K units of capital, R units of resources and Z percent of the knowledge/talent that is contained in the universe. Suppose resources, capital, & technology/talent are currently at R = 0.4 (trillion dollars of land, oil, coal, natural gas…), K = 2.5 (trillion dollars of machines, roads, networks…) and z = 1 (percent of all knowledge in the universe is known on Earth). • What is the economy’s short-run production function?

  11. Long Run Aggregate Supply The Economy’s Production Function • Example (continued): 2. Graph the economy’s short-run production function. L

  12. Long Run Aggregate Supply The Economy’s Production Function • Example (continued): 3. Suppose there are 9 million workers that are frictionally or structurally unemployed, and 135 million of the 144 million in the labor force are employed. Compute u, un, uc, real GDP, and Yp. 12 144 L

  13. Long Run Aggregate Supply The Economy’s Production Function • Example (continued): • Graph LRAS with AD. Yp = 12 PL = – 0.5 Y + 12.75 p LRAS 12.75 6.75 AD 0 Y 12

  14. Long Run Aggregate Supply The Economy’s Production Function • Example (continued): 5. Suppose there are 9 million workers that are frictionally or structurally unemployed, and 112 million of the 144 million in the labor force are employed. Compute u, un, uc, real GDP, and Yp. 11 144 121 L

  15. Long Run Aggregate Supply The Economy’s Production Function • Example (continued): 6. Suppose there are 9 million workers that are frictionally or structurally unemployed, and 135 million of the 144 million in the labor force are employed, with 50 million of them working 60 hours per week. Compute u, un, uc, real GDP, and Yp. 13 Since 50 million are working an extra 20 hours/wk, the effective size of the (fulltime) work force is 135 + 50/2 = 160 144 169 L

  16. Long Run Aggregate Supply The Economy’s Production Function • Example (continued): 7. Suppose technology rises to 1.1 percent. Re-graph the economy’s production function, and re-compute full-employment output. 13.2 Yp= 13.2 (trillion $) 144 L

  17. Long Run Aggregate Supply The Economy’s Production Function • Example (continued): 8. Graph the initial LRAS with AD and final LRAS p LRAS LRAS’ 12.75 6.75 AD 0 Y 12 13.2

  18. Short Run Aggregate Supply SRAS is the relationship between the quantity of real GDP supplied and p when all other influences on production plans remain the same • SRAS shifts upward (decreases) when • Expected inflation rises • Workers expecting the PL to rise will demand one-for-one adjustments in w Dp e = Dw • In the short-run, w is the most important factor to producing products • Inflation increases one-for-one in expected inflation • a price shock (up) occurs due to the nominal price of a resource like energy (r). • Government permanently changes the supply-side tax rate (t ) • Output gap Y – Yp widens • workers are being offered higher w and better benefits due to u being too low • In the short-run, it is believed this pushes inflation higher due to firms raising their prices. • This makes SRAS upward sloping. p = p e + r +t+ g (Y – Yp) p = g Y + pe+ r +t– g Yp

  19. Short Run Aggregate Supply • Example: In addition to R = 0.4 (trillion dollars of land…), K =2.5 (trillion dollars of machines…), Z = 1 (percent of all knowledge is known to man), Un = 9 (million frictionally or structurally unemployed workers), E = 135 (million), and L = 144 (million), suppose the sensitivity of inflation to the output gap is 0.5, expected inflation is 1 (percent), price shock is 0, and the supply-side tax rate is 5 (percent). 1. Graph the potential GDP you computed in part (3) with AD Yp = 12 p = g Y + p e+ r +t– g Yp

  20. Short Run Aggregate Supply • Example: In addition to R = 0.4 (trillion dollars of land…), K =2.5 (trillion dollars of machines…), Z = 1 (percent of all knowledge is known to man), Un = 9 (million frictionally or structurally unemployed workers), E = 135 (million), and L = 144 (million), suppose the sensitivity of inflation to the output gap is 0.5, expected inflation is 1 (percent), price shock is 0, and the supply-side tax rate is 5 (percent). 1. Graph the potential GDP you computed in part (3) with AD Yp = 12 p = g Y + p e+ r +t– g 12

  21. Short Run Aggregate Supply • Example: In addition to R = 0.4 (trillion dollars of land…), K =2.5 (trillion dollars of machines…), Z = 1 (percent of all knowledge is known to man), Un = 9 (million frictionally or structurally unemployed workers), E = 135 (million), and L = 144 (million), suppose the sensitivity of inflation to the output gap is 0.5, expected inflation is 1 (percent), price shock is 0, and the supply-side tax rate is 5 (percent). 1. Graph the potential GDP you computed in part (3) with AD Yp = 12 p = 0.5Y + p e+ r +t– 6

  22. Short Run Aggregate Supply • Example: In addition to R = 0.4 (trillion dollars of land…), K =2.5 (trillion dollars of machines…), Z = 1 (percent of all knowledge is known to man), Un = 9 (million frictionally or structurally unemployed workers), E = 135 (million), and L = 144 (million), suppose the sensitivity of inflation to the output gap is 0.5, expected inflation is 1 (percent), price shock is 0, and the supply-side tax rate is 5 (percent). 1. Graph the potential GDP you computed in part (3) with AD Yp = 12 p = 0.5Y + 1+ r +t– 6

  23. Short Run Aggregate Supply • Example: In addition to R = 0.4 (trillion dollars of land…), K =2.5 (trillion dollars of machines…), Z = 1 (percent of all knowledge is known to man), Un = 9 (million frictionally or structurally unemployed workers), E = 135 (million), and L = 144 (million), suppose the sensitivity of inflation to the output gap is 0.5, expected inflation is 1 (percent), price shock is 0, and the supply-side tax rate is 5 (percent). 1. Graph the potential GDP you computed in part (3) with AD Yp = 12 p = 0.5Y + 1+ 0 +t– 6

  24. Short Run Aggregate Supply • Example: In addition to R = 0.4 (trillion dollars of land…), K =2.5 (trillion dollars of machines…), Z = 1 (percent of all knowledge is known to man), Un = 9 (million frictionally or structurally unemployed workers), E = 135 (million), and L = 144 (million), suppose the sensitivity of inflation to the output gap is 0.5, expected inflation is 1 (percent), price shock is 0, and the supply-side tax rate is 5 (percent). 1. Graph the potential GDP you computed in part (3) with AD Yp = 12 p = 0.5Y + 1+ 0+ 5 – 6

  25. Short Run Aggregate Supply • Example: In addition to R = 0.4 (trillion dollars of land…), K =2.5 (trillion dollars of machines…), Z = 1 (percent of all knowledge is known to man), Un = 9 (million frictionally or structurally unemployed workers), E = 135 (million), and L = 144 (million), suppose the sensitivity of inflation to the output gap is 0.5, expected inflation is 1 (percent), price shock is 0, and the supply-side tax rate is 5 (percent). 1. Graph the potential GDP you computed in part (3) with AD Yp = 12 p = 0.5Y

  26. Short Run Aggregate Supply • Example (continued): 2. Graph SRAS: p = 0.5Y p SRAS 6 12 Y

  27. Short Run Aggregate Supply • Example (continued): 3. What happens if government cuts supply-side taxes by 1 percentage point? p =0.5Y +1+ 0 + 5 – 6 4 p SRAS SRAS’ Supply-side tax cuts increase SRAS. 6 -5 12 Y 13

  28. Short Run Aggregate Supply p = g Y + p e + r +t– g Yp

  29. Short Run Aggregate Supply • p = g Y + p e + r +t– g Yp • The Congress and President are in charge of fiscal policy. • Expansionary supply-side fiscal policy involves cutting t • Restrictive supply-side fiscal policy involves raising t • The Federal Reserve (our central bank) is in charge of monetary policy • Expansionary monetary policy lowers the federal funds interest rate • Restrictive monetary policy raises the federal funds interest rate

  30. Short Run Aggregate Supply • p = g Y + p e + r +t– g Yp • The Congress and President are in charge of fiscal policy. • Expansionary supply-side fiscal policy involves cutting t • Restrictive supply-side fiscal policy involves raising t • The Federal Reserve (our central bank) is in charge of monetary policy • Expansionary monetary policy lowers the federal funds interest rate • Restrictive monetary policy raises the federal funds interest rate

  31. Aggregate Market Model Equilibrium • Example (continued): 4. Graph LRAS with SRAS: Yp= 12p= 0.5Y p LRAS SRAS 6 12 Y

  32. Aggregate Market Model Equilibrium • Example (continued): • Suppose technology/talent increases by 0.1 percentage points. Show the effect of this on LRAS and SRAS. p LRAS LRAS’ SRAS Yp= 13.2 (trillion $) 6 12 13.2 Y

  33. Aggregate Market Model Equilibrium • Example (continued): • Suppose technology/talent increases by 0.1 percentage points. Show the effect of this on LRAS and SRAS. p LRAS LRAS’ SRAS SRAS’ Yp= 13.2 (trillion $) 6 p =0.5Y + 1 + 0 + 5 – 0.5 · 12 p =0.5Y – 0.6 -0.6 12 13.2 Y

  34. Aggregate Market Model Equilibrium • Example (continued): 6. Graph LRAS, AD & SRAS: Yp= 12 p= 0.5Yp= 12 – 0.5 Y p LRAS SRAS 6 AD 12 Y

  35. Aggregate Market Model Equilibrium • Example (continued): 7. Graph LRAS, AD & SRAS: Yp= 12 p= 0.5Yp= 11 – 0.5 Y p LRAS SRAS 5.5 AD 12 Y 11

  36. Aggregate Market Model Equilibrium • Example (continued): 7. Graph LRAS, AD & SRAS: Yp= 12 p= 0.5Yp= 11 – 0.5 Y p = g Y + p e + r +t– g Yp p LRAS SRAS 5.5 AD 12 Y 11

  37. Aggregate Market Model Equilibrium • Example (continued): 7. Graph LRAS, AD & SRAS: Yp= 12 p= 0.5Yp= 11 – 0.5 Y p = g Y + p e + r +t– g Yp p LRAS SRAS • Wages are inflexible, particularly downward • Need for active government policy 5.5 5.2 AD 12 Y 11

  38. Aggregate Market Model Equilibrium • Example (continued): 7. Graph LRAS, AD & SRAS: Yp= 12 p= 0.5Yp= 11 – 0.5 Y p = g Y + p e + r +t– g Yp p LRAS • Wages are inflexible, particularly downward • Need for active government policy SRAS 5.2 AD 12 Y

  39. Aggregate Market Model Equilibrium • Example (continued): 8. Graph LRAS, AD & SRAS: Yp= 12 p= 0.5Yp= 13 – 0.5 Y p LRAS SRAS 6.5 AD 12 Y 13

  40. Aggregate Market Model Equilibrium • Example (continued): 8. Graph LRAS, AD & SRAS: Yp= 12 p= 0.5Yp= 13 – 0.5 Y p= g Y + p e + r +t– g Yp p LRAS SRAS 6.5 AD 12 Y 13

  41. Aggregate Market Model Equilibrium • Example (continued): 8. Graph LRAS, AD & SRAS: Yp= 12 p= 0.5Yp= 13 – 0.5 Y p= g Y + p e + r +t– g Yp p LRAS SRAS 7.5 6.5 • Wages and prices are flexible AD 12 Y 13

  42. Aggregate Market Model Equilibrium • Example (continued): 8. Graph LRAS, AD & SRAS: Yp= 12 p= 0.5Yp= 13 – 0.5 Y p= g Y + p e + r +t– g Yp p LRAS SRAS 7.5 • Wages and prices are flexible AD 12 Y

  43. Positive Demand Shock AD can shift from temporary demand shocks in which the LRAS and SRAS do not shift

  44. Positive Demand Shock AD can shift from temporary demand shocks in which the LRAS and SRAS do not shift p LRAS SRAS 3 2 AD 13 12 Y

  45. Positive Demand Shock AD can shift from temporary demand shocks in which the LRAS and SRAS do not shift p LRAS SRAS 3.5 3 2 AD 13 12 Y

  46. Negative Demand Shock AD can shift from temporary demand shocks in which the LRAS and SRAS do not shift p LRAS SRAS 2 1.5 AD 11 12 Y

  47. Negative Demand Shock AD can shift from temporary demand shocks in which the LRAS and SRAS do not shift p LRAS SRAS 2 1.5 1.25 AD 11 12 Y

  48. Negative Demand Shock The Volcker Disinflation p LRAS SRAS 13.5 10.3 AD Yp Y

  49. Negative Demand Shock The Volcker Disinflation p LRAS SRAS 13.5 10.3 AD Yp Y

  50. Negative Demand Shock The Volcker Disinflation p LRAS SRAS 13.5 10.3 6.2 AD Yp Y

More Related