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Chapter 19 Aggregate Demand and Aggregate Supply Ch 19 Outline Business Cycle Aggregate Demand Curve (AD Curve) Aggregate Supply Curve (AS Curve) AD/AS Model Recession & Model Finishing Ch 16 Great! Two new kids on the block! Yeah. We introduce Chapter 19 You learn how the

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chapter 19

Chapter 19

Aggregate Demand and

Aggregate Supply

ch 19 outline
Ch 19 Outline
  • Business Cycle
  • Aggregate Demand Curve (AD Curve)
  • Aggregate Supply Curve (AS Curve)
  • AD/AS Model
  • Recession & Model
finishing ch 16
Finishing Ch 16

Great! Two new

kids on the block!

Yeah. We introduce

Chapter 19

You learn how the

economy falls into

rececession!

Macro:

Sink or swim?

Think & Win!

short run economic fluctuations
Short-Run Economic Fluctuations
  • Economic activity varies
  • Recession: drop in real GDP for two consecutive quarters.
three key facts about economic fluctuations
Three Key Facts About Economic Fluctuations
  • Economic Fluctuations are Unpredictable
  • Most Macro Variables Fluctuate Together
  • As Output Falls, Unemployment Rises
long run as curve
Long-Run AS Curve

Expand to Peak

Real

GDP

GDP trend

grows 3%

per year

Contract to trough

Time

economic fluctuations
Economic Fluctuations
  • Leading Economic Indicators (LEI) foreshadow changes
      • stock prices,
      • building permits,
      • initial unemployment insurance claims
      • money supply growth
      • length of average work-week
aggregate demand ad aggregate supply as
Aggregate Demand (AD) & Aggregate Supply (AS)
  • Aggregate: means “Total” or “Sum of All”
  • Economists use the model of aggregate demand and aggregate supply.
the basic model of economic fluctuations
The Basic Model of Economic Fluctuations
  • Two variables used in AD/AS model to analyze the short-run fluctuations:

1. real GDP

2. overall price level (I.e., CPI)

aggregate demand and aggregate supply
Aggregate Demand and Aggregate Supply
  • Aggregate Demand Curve shows quantity of goods and services demanded at different price levels.
aggregate demand
Aggregate Demand

Price

Level

AD = C + I + G + NX

PE

P2

Aggregate

Demand

Q2

QE

Quantity of Output

aggregate demand curve
Aggregate Demand Curve
  • AD = C + I + G + NX
  • Why AD Slopes down:
  • Wealth Effect on Consumption (C)
  • Trade Effect on Net Exports (NX)
  • Interest Rate Effect on Investment (I)
downward slope of ad
Downward Slope of AD
  • Wealth Effect:
  • Price Level (P) falls
  • People Feel Wealthier
  • Consumption (C) rises
downward slope of ad15
Downward Slope of AD
  • Trade Effect:
  • P falls
  • US goods now relatively cheap
  • US exports (NX) rise
downward slope of ad curve
Downward Slope of AD Curve
  • Interest-Rate Effect:
  • P falls
  • Interest Rate Falls
  • Investment Increases
aggregate demand17
Aggregate Demand

Price

Level

AD = C + I + G + NX

PE

P2

Aggregate

Demand

Q2

QE

Quantity of Output

shifts in ad curve ad rises
Shifts in AD Curve: AD Rises

Price

Level

C, I, G, or NX rises

AD

Aggregate Demand

Quantity of Output

factors that shift ad curve right
Factors that shift AD Curve Right
  • Consumers become optimistic (C)
  • Businesses become optimistic (I)
  • Foreigners buy US Goods (NX)
  • Congress Raises Gov’t Purchases (G)
  • The Fed buys Gov’t Securities (C, I)
shifts in ad curve ad falls
Shifts in AD Curve: AD Falls

Price

Level

C, I, G or NX Falls

AD

Aggregate Demand

Quantity of Output

long run aggregate supply as curve
Long-Run Aggregate Supply (AS) Curve
  • Long-Run Aggregate Supply Curve (LRAS) is vertical at full-employment GDP
  • LRAS depends on:
  • Resource Base
  • Technology
  • Natural Rate of Unemployment
long run as curve24
Long-Run AS Curve

The Long-Run

Aggregate

Supply (LRAS)

Curve

Price

Level

When Expected

Inflation = Actual

Inflation, economy

on LRAS

Quantity of Output

long run as curve25
Long-Run AS Curve

The Long-Run

Aggregate

Supply (LRAS)

Curve

Price

Level

Output level

is what economy produces

when unemployment

at natural rate

Quantity of Output

shifts in lras curve
Shifts in LRAS Curve
  • Over time, these shift LRAS right:
  • Greater Resource Base
  • Better Technology
  • Lower Natural Rate of Unemployment
long run as curve27
Long-Run AS Curve

Price

Level

The Long-Run

Aggregate

Supply (LRAS)

Curve

Quantity of Output

short run aggregate supply curve slopes upward
Short-Run Aggregate Supply CurveSlopes Upward

Price

Level

SR Aggregate

Supply (0%)

Quantity of Output

short run aggregate supply sras curve
Short-Run Aggregate Supply (SRAS) Curve
  • In short run:
  • A rise in pricelevel
  • Raises economy’s output level
  • …and vice versa
why sr aggregate supply curve slopes
Why SR Aggregate Supply Curve Slopes
  • Keynesian Sticky-Wage Theory:
  • Wages fixed in short-run by contract
  • If inflation greater than expected, real wage falls
  • Profit margins widen
  • Firm’s expand output.
short run aggregate supply curve
Short-Run Aggregate Supply Curve

Price

Level

Aggregate

Supply (0%)

P2=102

PN=100

Q2

QN

Quantity of Output

short run aggregate supply curve33
Short-Run Aggregate Supply Curve

Price

Level

Aggregate

Supply (0%)

P2=102

PN=100

Q2

QN

Quantity of Output

why sr as curve shifts
Why SR AS Curve Shifts
  • Two reasons why SRAS shifts:
  • Changes in Inflationary Expectations
  • Change in resource prices (e.g., wage)
sras falls because inflationary expectations rise workers win wage hike
SRAS Falls…Because Inflationary Expectations Rise &Workers Win Wage Hike

AS(2%)

Price

Level

Aggregate Supply

AS(0%)

Quantity of Output

sras rises inflationary expectations wage rate or resource prices fall
SRAS Rises…Inflationary Expectations Wage Rate or Resource Prices Fall

AS (2%)

Price

Level

Aggregate Supply

AS (0%)

Quantity of Output

equilibrium in the long run
Equilibrium in the Long-Run

LRAS

Price

Level

SR Aggregate

Supply (0%)

PN

Aggregate

Demand

QN

Quantity of Output

sources of recession
Sources of Recession
  • Two reasons:
  • AD falls (shifts left)
    • C, I, G or NX falls
  • AS falls (shifts left) Stagflation
    • Higher resource costs,
    • inflationary expectations
a decrease in aggregate demand
A Decrease in Aggregate Demand

Price

Level

Aggregate

Supply (0%)

PN

Aggregate

Demand

QN

Quantity of Output

a decrease in aggregate demand41
A Decrease in Aggregate Demand

Price

Level

Aggregate

Supply (0%)

PN

Aggregate

Demand

QN

Quantity of Output

a decrease in aggregate demand42
A Decrease in Aggregate Demand

Price

Level

Aggregate

Supply (0%)

PN

P2

Aggregate

Demand

Q2

QN

Quantity of Output

economy adjusts to ad drop
Economy Adjusts to AD Drop

SRAS (0%)

Price

Level

SRAS (-5%)

Economy Adjusts By Itself!!!

Aggregate

Demand

PN

QN

Quantity of Output

jm keynes
JM Keynes
  • When AD tanks, get Depression
  • Wages are “sticky”
  • Stuck in Depression
  • Need Gov’t to increase spending or Cut Taxes
  • AD rises
  • Output rises

When Congress changes

taxes (T) or

government

spending (G), this is

called Fiscal Policy

two ways for gov t to increase ad
Two Ways For Gov’t To Increase AD
  • Congress can cut taxes or increase government purchases
  • The Fed can increase the money supply

Fiscal Policy

Monetary Policy

aggregate demand curve falls
Aggregate Demand Curve Falls

Price

Level

Aggregate

Supply

Output at

Full Employment

Aggregate

Demand

Quantity of Output

government spending raises ad
Government Spending Raises AD

Price

Level

Aggregate

Supply

Aggregate

Demand

Quantity of Output

source of recession a decrease in sr aggregate supply
Source of RecessionA Decrease in SR Aggregate Supply
  • OPEC energy price hike.
    • A fall in total output below full output
    • An increase in unemployment

Roar

a decrease in aggregate supply
A Decrease in Aggregate Supply

Price

Level

Aggregate

Supply

PN

Aggregate

Demand

QN

Quantity of Output

a decrease in aggregate supply50
A Decrease in Aggregate Supply

Aggregate

Supply (2%)

Price

Level

Aggregate

Supply (0%)

PN

Aggregate

Demand

QN

Quantity of Output

a decrease in aggregate supply51
A Decrease in Aggregate Supply

AS (2%)

Price

Level

AS (0%)

P2

PN

Aggregate

Demand

Q2

QN

Quantity of Output

economy adjusts to drop in as
Economy Adjusts to Drop in AS

AS (2%)

Price

Level

AS (0%)

P2

Economy Adjusts By Itself!!!

PN

Aggregate

Demand

Q2

QN

Quantity of Output

wrap up time
Wrap-Up Time

Didn’t feel like a fish outta

wadah taday!

ch 19 over
Ch 19 Over
  • The End