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Chapter 08 Aggregate Demand and Aggregate Supply. Chapter Outline. Aggregate Demand Aggregate Supply Shifts in Aggregate Demand and Aggregate Supply Causes of Inflation Supply-Side Economics How the Government Can Influence (but probably not control) the Economy. Aggregate Demand.

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Chapter 08 aggregate demand and aggregate supply

Chapter 08Aggregate Demand and Aggregate Supply


Chapter outline
Chapter Outline

  • Aggregate Demand

  • Aggregate Supply

  • Shifts in Aggregate Demand and Aggregate Supply

  • Causes of Inflation

  • Supply-Side Economics

  • How the Government Can Influence (but probably not control) the Economy


Aggregate demand
Aggregate Demand

  • Aggregate Demand: the amounts of real domestic output which domestic consumers, businesses, governments, and foreign buyers collectively will desire to purchase at each possible price level


Figure 1 aggregate demand

PI

AD

RGDP

Figure 1 Aggregate Demand


Why aggregate demand is downward sloping
Why Aggregate Demand is Downward Sloping

  • Real Balances Effect

    • Because higher prices reduce real spending power, prices and output are negatively related.

  • Foreign Purchases Effect

    • When domestic prices are high, we will export less to foreign buyers and we will import more from foreign producers. Therefore higher prices leads to less domestic output.

  • Interest Rate Effect

    • higher prices lead to inflation which leads to less borrowing and a lowering of RGDP


Aggregate supply
Aggregate Supply

  • Aggregate Supply: the level of real domestic output available at each possible price level


Figure 2 the aggregate supply curve

AS

PI

RGDP

Figure 2 The Aggregate Supply Curve

Classical Range

Intermediate Range

Keynesian Range


The ranges of as
The Ranges of AS

  • Keynesian Range

    • Large amounts of unemployment make it so that increases in aggregate demand have no affect on wages or prices.

  • Classical Range

    • Full employment makes it so that increases in aggregate demand only increase wages or prices.

  • Intermediate Range

    • Some sectors of the economy reach full employment more quickly than others.


Variables that shift aggregate demand
Variables that Shift Aggregate Demand

  • Taxes

  • Interest Rates

  • Confidence

  • Strength of the Dollar

  • Government Spending



Figure 3 ad increases

PI

AS

PI’

PI*

AD’

AD

RGDP*

RGDP’

RGDP

Figure 3 AD Increases


Figure 4 ad decreases

PI

AS

PI*

PI’

AD

AD’

RGDP’

RGDP*

RGDP

Figure 4 AD Decreases


Variables that shift as
Variables that Shift AS

  • Input Prices

  • Productivity

  • Government Regulation



Figure 5 increase in as

PI

AS

AS’

PI*

PI’

AD

RGDP

RGDP*

RGDP’

Figure 5 Increase in AS


Figure 6 decrease in as

PI

AS’

AS

PI’

PI*

AD

RGDP’

RGDP*

RGDP

Figure 6 Decrease in AS


Causes of inflation
Causes of Inflation

  • Demand Pull Inflation: inflation caused by an increase in aggregate demand

  • Cost Push Inflation: inflation caused by a decrease in aggregate supply


Government influence aggregate demand
Government Influence: Aggregate Demand

  • Government can influence economic activity with aggregate demand side policies affecting:

    • Taxes

    • Government Spending

    • Interest Rates


Government influence aggregate supply
Government Influence: Aggregate Supply

  • Government can influence economic activity with aggregate supply side policies affecting

    • input costs (labor and wage)

    • reducing regulation

    • Increase incentives to

      • Work

      • Take Risks

  • The actions are call Supply Side Economics


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