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Chapter 20 Aggregate Demand and Supply Key Concepts Summary Practice Quiz Internet Exercises In this chapter, you will learn to solve these economic puzzles: Why does the aggregate supply curve have three different segments?

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chapter 20 aggregate demand and supply
Chapter 20Aggregate Demand and Supply
  • Key Concepts
  • Summary
  • Practice Quiz
  • Internet Exercises
in this chapter you will learn to solve these economic puzzles
In this chapter, you will learn to solve these economic puzzles:

Why does the aggregate supply curve have three different segments?

Was John Maynard Keynes’s prescription for the Great Depression right?

Would the greenhouse effect cause inflation, unemployment, or both?

what is the aggregate demand curve
What is the Aggregate Demand Curve?

The curve shows the level of real GDP purchased by households, businesses, government, and foreigners at different price levels during a time period, ceteris paribus

what does the horizontal axis measure
What does the Horizontal Axis measure?

The value of final goods and services included in real GDP measured in base year dollars

what does the vertical axis measure
What does the Vertical Axis measure?

It is an index of the overall price level, such as the GDP deflator or the CPI

why does the aggregate demand curve slope downward to the right
Why does the Aggregate Demand Curve slope downward to the right?
  • Real balance wealth effect
  • Interest rate effect
  • Net exports effect
what is the real balance effect
What is theReal Balance Effect?

Consumers spend more on goods and services because lower prices make their dollars more valuable

what is the interest rate effect
What is theInterest Rate Effect?

Assuming fixed credit, an increase in the price level translates through higher interest rates into a lower real GDP

what is the net exports effect
What is theNet Exports Effect?

A higher domestic price level makes U.S. goods more expensive compared to foreign goods, exports decrease, imports increase, decreasing real GDP

slide10

The Aggregate Demand Curve

$200

Price Level

A

$150

B

$100

AD

$50

Real GDP

12

4

8

6

10

2

what can cause a shift in the aggregate demand curve
What can cause a shift in the Aggregate Demand Curve?

Consumption, investments, government spending and net exports can change

slide12

A Shift in the Aggregate Demand Curve

200

150

Price Level (CPI)

A

B

100

AD2

50

AD1

Real GDP

12

4

6

10

2

8

what is the aggregate supply curve
What is theAggregate Supply Curve?

The curve that shows the level of real GDP produced at different price levels during a time period, ceteris paribus

why did keynes assume fixed product prices and wages
Why did Keynes assume fixed product prices and wages?

During a deep recession or depression, there are many idle resources in the economy

why do idle resources mean fixed prices
Why do idle Resources mean Fixed Prices?

Producers are willing to sell additional output at current prices because there is plenty of resources to go around for everyone who wants them

why do idle resources mean fixed wages
Why do idle Resources mean Fixed Wages?

The supply of unemployed workers willing to work for the prevailing wage rate diminishes the power of workers to increase their wages

slide18

The Keynesian Horizontal Aggregate Supply Curve

200

150

Price Level (CPI)

E1

E2

AS

100

AD2

50

AD1

Real GDP

12

4

8

6

10

2

slide19

Price level remains constant, while real GDP and employment rise

Aggregate demand increases and the economy moves from E1 to E2

Government spending (G) increases

according to keynes what will a shift in aggregate demand do
According to Keynes, what will a shift in Aggregate Demand do?

It will restore a depressed economy to full employment

slide21

The Keynesian Horizontal Aggregate Supply Curve

200

Full employment

150

Price Level (CPI)

E1

E2

AS

100

AD2

50

AD1

Real GDP

12

4

8

6

10

2

what is the classical view of the aggregate supply curve
What is the Classical view of the Aggregate Supply Curve?

It is a vertical line at the full employment output

according to the classical economists where does the economy normally operate
According to the Classical Economists, where does the economy normally operate?

The economy normally operates at its full employment level

how do the classical economists view prices and costs
How do the Classical Economists view Prices and Costs?

The price level of products and production costs change by the same percentage in order to maintain full employment

slide25

The Classical Aggregate Supply Curve

AS

Surplus

200

Full employment

E1

150

E

Price Level (CPI)

100

E2

AD1

50

AD2

Real GDP

12

14

16

17

6

2

4

8

10

slide26

Three Ranges of the Aggregate Supply Curve

AS

Classical Range

Full Employment

Intermediate Range

Price Level

Keynesian Range

Real GDP

YK

YF

slide27

Increasing Demand

AS

200

Price Level

150

AD6

100

AD5

Full Employment

AD4

50

AD3

AD2

Real GDP

AD1

6

0

2

4

8

10

12

what factors can cause a shift in the aggregate supply curve
What factors can cause a shift in theAggregate Supply Curve?

A change in ~

  • resource prices
  • technology
  • taxes
  • subsidies
  • regulations
slide29

A Rightward Shift in the Aggregate Supply Curve

AS1

AS2

200

E1

E2

150

Full employment

100

Price Level

AD

50

Real GDP

12

14

16

17

6

2

4

8

10

slide30

Increase in the aggregate supply curve

Change in one or more nonprice-level determinants: resource prices, technological change, taxes, subsidies, and regulations

what is cost push inflation
What isCost Push Inflation?

A rise in the general price level resulting from an increase in the cost of production

slide33

Cost Push Inflation

AS2

AS1

200

Price Level

E2

150

Full employment

100

E1

AD

50

Real GDP

12

14

16

17

6

2

4

8

10

what is demand pull inflation
What isDemand Pull Inflation?

A rise in the general price level resulting from an excess of total spending

slide35

Demand Pull Inflation

AS

200

Price Level

Full employment

150

E2

AD2

100

E1

50

AD1

Real GDP

12

14

16

17

6

2

4

8

10

what determines the business cycle
What determines the Business Cycle?

Shifts in the aggregate demand and aggregate supply curves

key concepts38
Key Concepts
  • What is the Aggregate Demand Curve?
  • Why does the Aggregate Demand Curve slope downward to the right?
  • What can cause a shift in the Aggregate Demand Curve?
  • What is the Aggregate Supply Curve?
  • Why did Keynes assume fixed product prices and wages?
  • What kind of Supply Curve would explain Fixed Prices and Wages?
key concepts cont
Key Concepts cont.
  • According to Keynes, what will a shift in Aggregate Demand do?
  • What is the Classical view of the Aggregate Supply Curve?
  • According to the Classical Economists, where does the economy normally operate?
  • What factors can cause a shift in the Aggregate Supply Curve?
  • What are the two types of Inflation?
slide41

The aggregate demand curve shows the level of real GDP purchased in the economy at different price levels during a period of time.

slide43

(1) The real balances or wealth effect is the impact on real GDP caused by the inverse relationship between the purchasing power of fixed value financial assets and inflation, which causes a shift in the consumption schedule.

slide44

(2) The interest-rate effect assumes a fixed money supply, and, therefore, inflation increases the demand for money. As the demand for money increases, the interest rate rises, causing consumption and investment spending to fall.

slide45

(3) The net exports effect is the impact on real GDP caused by the inverse relationship between net exports and inflation. An increase in the U.S. price level tends to reduce U.S. exports and increase imports, and vice versa.

slide46

A Shift in the Aggregate Demand Curve

200

150

Price Level (CPI)

A

B

100

AD2

50

AD1

Real GDP

12

4

6

10

2

8

slide47

The aggregate supply curve shows the level of real GDP that the economy will produce at different possible price levels. The shape of the aggregate supply curve depends on the flexibility of prices and wages as real GDP expands and contracts. The aggregate supply curve has three ranges:

slide48

(1) The Keynesian range of the curve is horizontal because neither the price level nor production costs will increase when there is substantial unemployment in the economy.

slide49

(2) In the intermediate range, both prices and costs rise as real GDP rises toward full employment. Prices and production costs rise because of bottlenecks, the stronger bargaining power of labor, and the utilization of less productive workers and capital

slide50

(3) The classical range is the vertical segment of the aggregate supply curve. It coincides with the full-employment output. Because output is at its maximum, increases in aggregate demand will only cause a rise in the price level.

slide51

Three Ranges of the Aggregate Supply Curve

AS

Classical Range

Full Employment

Intermediate Range

Price Level

Keynesian Range

Real GDP

YK

YF

slide52

Aggregate demand and aggregate supply analysis determines the equilibrium price level and the equilibrium real GDP by the intersection of the aggregate demand and the aggregate supply curves. In macroeconomic equilibrium, businesses neither overestimate nor underestimate the real GDP demanded at the prevailing price level.

slide53

Stagflation exists when an economy experiences inflation and unemployment simultaneously. Holding aggregate demand constant, a decrease in aggregate supply results in the unhealthy condition of a rise in the price level and a fall in real GDP and employment.

slide54

Cost-push inflation is inflation that results from a decrease in the aggregate supply curve while the aggregate demand curve remains fixed. Cost-push inflation is undesirable because it is accompanied by declines in both real GDP and employment.

slide55

Cost Push Inflation

AS2

AS1

200

Price Level

E2

150

Full employment

100

E1

AD

50

Real GDP

12

14

16

17

6

2

4

8

10

slide56

Demand-pull inflation is inflation that results from an increase in the aggregate demand curve in both the classical and the intermediate ranges of the aggregate supply curve while the aggregate supply curve is fixed.

slide57

Demand Pull Inflation

AS

200

Price Level

Full employment

150

E2

AD2

100

E1

50

AD1

Real GDP

12

14

16

17

6

2

4

8

10

chapter 20 quiz
Chapter 20 Quiz

©2000 South-Western College Publishing

slide59
1. The aggregate demand curve is defined as

a. the net national product.

b. the sum of wages, rent, interest, and profits.

c. the real GDP purchased at different possible price levels.

d. the total dollar value of household expectations.

C. Answers a, b, and c are not real GDP purchases at different possible price levels during a time period.

slide60
2. When the supply of credit is fixed, an increase in the price level stimulates the demand for credit, which, in turn, reduces consumption and investment spending. This effect is called the

a. real balance effect.

b. interest-rate effect.

c. net exports effect.

d. substitution effect.

B. At a high price level, the demand for borrowed money increases and results in higher cost of borrowing (interest rates). Higher interest rates result in lower consumption and investment spending.

slide61
3. The real balance effect occurs because a higher price level reduces the real value of people’s

a. financial assets.

b. wages.

c. unpaid debt.

d. physical investments.

A. As price increase the dollars people receive in their paychecks and wealth are worth less. As a result, real GDP demand decreases.

slide62
4. The net exports effect is the inverse relationship between net exports and the _______of an economy.

a. Real GDP.

b. GDP deflator.

c. Price level.

d. Consumption spending.

C. A higher domestic price level makes U.S. goods more expensive relative to foreign goods and vice versa.

slide63
5. Which of the following will shift the aggregate demand curve to the left?

a. An increase in exports.

b. An increase in investment.

c. An increase in government spending.

d. A decrease in government spending.

D. Answers a, b, c shift the aggregate demand curve to the right.

slide64
6. Which of the following will not shift the aggregate demand curve to the left?

a. Consumers become more optimistic about the future.

b. Government spending decreases.

c. Business optimism decreases.

d. Consumers become pessimistic about the future.

A. Answers b, c and d shift the aggregate demand curve leftward.

slide65
7. The popular theory prior to the Great Depression that the economy will automatically adjust to achieve full employment is

a. supply-side economics.

b. Keynesian economics.

c. classical economics.

d. mercantilism.

C. Supply-side economic concerns shifts in aggregate supply. Keynesians do not believe the economy automatically adjusts to full employment. Mercantilism is the idea that gold or silver is the source of a nation’s wealth.

slide66
8. Classical economists believed that the

a. price system was stable.

b. goal of full employment was impossible.

c. price system automatically adjusts the economy to full employment in the long run.

d. government should not attempt to restore full employment.

C. This is a key assumption for the vertical shape of the classical aggregate supply curve.

slide67
9. Which of the following is not a range on the eclectic or general view of the aggregate supply curve?

a. Classical range.

b. Keynesian range.

c. Intermediate range.

d. Monetary range.

D. Answers a, b, and c are the three district ranges of the aggregate supply at a level of real GDP below full employment.

slide68

Three Ranges of the Aggregate Supply Curve

AS

Classical Range

Full Employment

Intermediate Range

Price Level

Keynesian Range

Real GDP

YK

YF

slide69
10. Macroeconomic equilibrium occurs when

a. aggregate supply exceeds aggregate demand.

b. the economy is at full employment.

c. aggregate demand equals aggregate supply.

d. aggregate demand equals the average price level.

C. Note that aggregate demand can equal aggregate supply at a level of real GDP below full employment.

slide70
11. Along the classical or vertical range of the aggregate supply curve, a decrease in the aggregate demand curve will decrease

a. both the price level and real GDP.

b. only real GDP.

c. only the price level.

d. neither real GDP or the price level.

C. Along the vertical range of the aggregate supply curve, the economy is at full employment and only the price level changes.

slide71
12. Other factors held constant, a decrease in resource prices will shift the aggregate

a. demand curve leftward.

b. demand curve rightward.

c. supply curve leftward.

d. supply curve rightward.

D. Changes in production costs do not affect the aggregate demand curve.

slide72
13. Assuming a fixed aggregate demand curve, a leftward shift in the aggregate supply curve causes a (an)

a. increase in the price level and a decrease in real GDP.

b. increase in the price level and an increase in real GDP.

c. decrease in the price level and a decrease in real GDP.

d. decrease in the price level and an increase in real GDP.

A.

slide73

Cost Push Inflation

AS2

AS1

200

Price Level

E2

150

Full employment

E1

100

AD

50

Real GDP

12

14

16

17

6

2

4

8

10

slide74
14. An increase in the price level caused by a rightward shift of the aggregate demand curve is called

a. cost-push inflation.

b. supply shock inflation.

c. demand shock inflation.

d. demand-pull inflation.

D.

slide75

Demand Pull Inflation

AS

200

Price Level

Full employment

150

E2

AD2

E1

100

50

AD1

Real GDP

12

14

16

17

6

2

4

8

10

slide76
15. Suppose workers become pessimistic about their future employment, which causes them to save more and spend less. If the economy is on the intermediate range of the aggregate supply curve, then

a. both real GDP and the price level will fall.

b. real GDP will fall and the price level will rise.

c. real GDP will rise and the price level will fall.

d. both real GDP and the price level will rise.

A. A leftward movement of the aggregate demand curve along a downward sloping aggregate supply curve will result in lower prices and less employment.

internet exercises
Internet Exercises

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