1 / 30

Unit Four: Aggregate Model

Unit Four: Aggregate Model. Topic: Aggregate Model (hmm…). Learning Targets. I will understand the aggregate model to the extent that I can explain how changes in AD and SRAS can create economic change. I will understand how stagflation occurs in an economy.

kiet
Download Presentation

Unit Four: Aggregate Model

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. Unit Four: Aggregate Model Topic: Aggregate Model (hmm…)

  2. Learning Targets • I will understand the aggregate model to the extent that I can explain how changes in AD and SRAS can create economic change. • I will understand how stagflation occurs in an economy. • I will be able to explain how policies can be instituted to fix GDP gaps.

  3. REMEMBER • Short run: cannot change production capacity (represented by points on PPC). • Long run: must have a change in production capacity (how much you CAN produce); growth requires new and/or better resources.

  4. Economic Fluctuations • Irregular and unpredictable • Most measures of macroeconomics (national income accounts) fluctuate together. • If output (GDPr or Y) falls, it means that unemployment (U) rises.

  5. Short Run Variables • Output (real GDP) • Price level (changes are measured by CPI or deflator) • We will use the aggregate model as our short run model.

  6. Aggregate Model • Def: shows equilibrium output (GDPr) and price level (PL) in the economy. • Explains short-run fluctuations in economic activity around long-run trends.

  7. Short-Run Aggregate Model U.S. PL AS Pe AD Qe GDPr

  8. Aggregate Demand (AD) • Def: shows the quantity of output (GDPr) that consumers desire at each and every price level (PL). • The relationship between AD and PL is an inverse relationship (like D and P), so the law of demand still applies.

  9. Reasons for the Downward-Sloping AD Curve • Real-balances (wealth) effect: ↑ PL => ↓ purchasing power => ↓C • Interest-rate effect: (assume a fixed money supply) ↑ PL => ↑ D money => ↑ interest rates => ↓ Ig • Foreign purchases (exchange-rate) effect: U.S. ↑ PL relative to foreign PL, foreign demand for U.S. goods fall and Americans buy more foreign goods (reduces Xn).

  10. Shifts in AD • The AD curve shifts like the D curve: • an increase in AD shifts the curve to the right • a decrease in AD shifts the curve to the left. • There are four factors (determinants) which can shift the AD curve.

  11. Determinants of AD • Consumption (C) • Income, interest rates, wealth, expectations, debt, taxes • Investment (Ig) • Interest rates, taxes, expectations, money supply, loanable funds market • Government spending (G) • Tax revenue, borrowing, fiscal policy • Net exports (Xn) • National income abroad, exchange rates

  12. AD Practice Questions For each of the following, state what happens to AD, PL and GDPr. • Americans are more concerned about saving for retirement. ↓ C=> ↓ AD => ↓ PL and ↓ GDPr • Government increases investment tax credits. ↑ Ig => ↑ AD => ↑ PL and ↑ GDPr • A recession occurs in Europe. ↓ Xn => ↓ AD => ↓ PL and ↓ GDPr

  13. Aggregate Supply (AS) • Def: shows the quantity of output (GDPr) that producers will provide at each and every price level (PL). • The relationship between AS and PL is an direct relationship (like S and P), so the law of supply still applies.

  14. Reasons for the Upward-Sloping AS Curve • Sticky-wage theory: nominal wages are slow to adjust to economic change (contracts, etc.) • Sticky-price theory: prices of some goods and services are slow to respond to economic change (menu costs) • Misperceptions theory: change in the overall PL can temporarily mislead suppliers about what is happening in their individual markets.

  15. Shifts in AS • The AS curve shifts like the S curve: • an increase in AS shifts the curve to the right • a decrease in AS shifts the curve to the left. • There are four factors (determinants) which can shift the AS curve.

  16. Determinants of AS • Expectations of price changes • Ex: Higher prices expected => higher nominal wages => decrease in AS (which actually creates higher prices) • Changes in resource cost • Ex: Minimum wage increases => increased resource cost => decreased AS • Change in productivity • Changes in legal requirements • Businesses taxes or gov’t regulations

  17. AS Practice Questions For each of the following, state what happens to SRAS, PL and GDPr. • Minimum wage increases. ↑ labor cost => ↓ SRAS => ↑ PL and ↓ GDPr • Government increases environmental regulations. ↑ cost => ↓ SRAS => ↑ PL and ↓ GDPr • Businesses expect higher prices in the future. ↑nominal wages => ↓ SRAS => ↑ PL and ↓ GDPr

  18. Long-Run Aggregate Supply • The AS curve is vertical in the LR because GDPr depends on the availability of resources (like full employment on the PPC). • Full employment is realized at the LRAS. LRAS = Q* = potential GDPr = full employment • Quantity of GDPr does not change with PL in the LR.

  19. Long-Run Aggregate Model U.S. PL LRAS AS Pe AD Qe Y* GDPr

  20. Shifts in LRAS • The LRAS curve (and full employment on PPC) ONLY shifts if: • Change in the amount of resources • Change in the productivity of resources • Change in technology • If there is economic GROWTH, the LRAS will shift RIGHT. • If there is economic DECLINE, the LRAS curve will shift LEFT.

  21. LRAS Practice Questions For each of the following, state whether LRAS will increase or decrease. • Capital stock increases. ↑ LRAS • Immigration increases. ↑ LRAS 3. Immigrants are deported. ↓ LRAS 4. Fewer college degrees are awarded. ↓ LRAS

  22. SR to LR Shifts • When there is a change in either SRAS or AD, the corresponding curve will shift, creating a short-run fluctuation. • In the long run, the economy will return to the natural rate of unemployment (full-employment at LRAS) either naturally or because of fiscal policy or monetary policy.

  23. Important Note about LR • As resources increase, it creates economic growth. • The general trend in the money supply is growth (overall, the money supply is increasing). • As these two continuously grow, PL continuously rises.

  24. Recession • Def (on the graph): actual GDPr is lower than Q*; there is unemployment. • Gov’t reaction: expansionary fiscal policy (↑ G and ↓ T); G will (hopefully) increase employment. • Fed reaction: expansionary monetary policy (buy bonds, ↓ discount rate, and ↓ reserve ratio); increasing the money supply means lower interest rates, which encourages Ig. • With these policies, the economy should return to Q*.

  25. Inflation • Def (on the graph): actual GDPr is greater than Q*. • Gov’t reaction: contractionary fiscal policy (↓ G and ↑ T); hopefully discourages spending. • Fed reaction: contractionary monetary policy (sell bonds, ↑ discount rate, and ↑ reserve ratio); decreasing money supply causes an increase in interest rates, which decrease Ig. • With these policies, the economy should return to Q*.

  26. Crowding-Out Effect • Def: increased gov’t spending crowds out investment spending. • ↑ G => ↑ AD => ↑D for money => ↑ i => ↓ Ig, partially offsetting the ↑ AD.

  27. Stagflation • Def: a period of increasing unemployment AND inflation. • Usually occurs when there are supply shocks (decrease in SRAS)

  28. Wage-Price Spiral • Def: higher prices leading to higher wages, which in turn leads to higher prices. • Can occur when SRAS decreases (expected higher prices lead to expected higher wages which create a decrease in SRAS which creates higher prices…whew!)

  29. Decrease in AD or SRAS • ↓ AD => ↓ wages => ↑ SRAS • ↓ SRAS => expansionary policy => ↑ AD…OR…if there is no expansionary policy (or it doesn’t work), then economic decline.

  30. Increase in AD or SRAS • ↑ AD => ↑ PL and ↑ GDPr => ↑ wages => ↓ SRAS (or contractionary policy) => back to Y* • ↑ SRAS => ↓ PL and ↑ GDPr => ↑ Y* (because of new capital investment, etc.)

More Related