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Chapter 4. Skating to Where the Puck is Going Aggregate Supply and Aggregate Demand. LEARNING OBJECTIVES. Aggregate Supply and supply shocks Aggregate Demand and a list demand shock
Skating to Where the Puck is Going
Aggregate Supply and Aggregate Demand
Aggregate Supply and supply shocks
Aggregate Demand and a list demand shock
Use matches and mismatches between aggregate supply and aggregate demand to explain the “Yes” and “No” answers to the fundamental macroeconomic question
“Yes” and “No” answers about origins, expectations, and market responses to business cycles
Supply plans for existing inputs determine aggregate quantity supplied. Supply plans to increase quantity and quality of inputs, together with supply shocks, change aggregate supply.
Macroeconomic players consumers, businesses, government make two kinds of plans for supplying Canadian real GDP
a) supply plans for existing inputs
b) supply plans to increase inputs
Aggregate quantity suppliedquantity of real GDP players plan to supply at different average price levels
Law of aggregate supplyas average level of prices rises, aggregate quantity supplied increases (up to maximum of potential GDP)
b) Supply plans to increase quantity or quality of inputs cause increase in aggregate supply — increase in economy’s capacity to produce real GDP
Positive supply shocks directly decrease costs or improve productivity, increasing aggregate supply
Demand plans determine aggregate quantity demanded. Demand shocks — from changes in expectations, interest rates, government policy, GDP in R.O.W., exchange rates — change aggregate demand.
All macroeconomic players — consumers, businesses, government, R.O.W.make demand plans for spending, like microeconomic choices about quantity demanded
Aggregate quantity demandedquantity of real GDP players plan to demand at different average price levels
Law of aggregate demandas average level of prices rises, aggregate quantity demanded decreases
Businesses plan investment spending (I)for new factories and equipment. Iplans are volatile.
Government spending plans (G) for products/services set by budget
R.O.W. spending plans (X) for Canadian exports
subtract imports (IM) from all other planned spending to get net exports (X — IM) = difference between what Canada exports and imports
Demand shocksfactors, other than average prices, changing aggregate demand
Aggregate demand changes with expectations, interest rates, government policy, GDP in R.O.W., exchange rates
more pessimistic expectations
higher interest rates
lower government spending and/or higher taxes
decreased GDP in R.O.W.
higher value Canadian dollar
Positive demand shocks increase aggregate demand
more optimistic expectations
lower interest rates
higher government spending and/or lower taxes
increased GDP in R.O.W.
lower value Canadian dollar
Matches between aggregate supply and aggregate demand give equilibrium, Say’s Law, and “Yes” answer; mismatches give Keynes’s business cycles, demand and supply shocks, and “No” answer.
“Yes” answermacroeconomic equilibrium with existing inputs when aggregate demand matchesaggregate supply
AS choices based on expectations of what price level and aggregate demand will be when products/services get to market
price level and AD what suppliers expected
Real GDP = potential GDP; inputs fully employed
Say’s Law — supply creates its own demand
add savings and investment to explain growth in living standards over time (real GDP per person)
savings threaten Say’s Law, since all income in input markets not spent demanding products/services in output markets
interest rate is price of loanable funds
if banks loan savings to businesses that use it for investment spending, offsets consumer savings, restoring equality between aggregate income and aggregate spending
Investment spending increases inputs, so potential GDP and real GDP per person increase over time
aggregate supply and aggregate demand both increase, full employment continues, average prices stay stable
aggregate supply choices based on expectations of what price level and aggregate demand will be when products/services get to market
expectations disappointed,outcomes do not work out as planned
adjustments — expansions and contractions — necessary to get back to smart choices
Keynes’s business cycles
negative demand shock causes recessionary gap — falling average prices, decreased real GDP, increased unemployment
positive demand shock causes inflationary gap —rising average prices increased real GDP, decreased unemployment
demand shocks cause unemployment and inflation to move in opposite directions, like Philips Curve
negative supply shock causes stagflation —rising average prices, decreased real GDP, increased unemployment
positive supply shock causes falling average prices, increased real GDP, decreased unemployment
supply shocks cause unemployment and inflation to move in same direction
agree on descriptions of equilibrium and impact of demand and supply shocks
disagree on origins of shocks and how quickly markets adjust
“Yes” and “No” camps disagree about external/internal origins of shocks, about rational/volatile expectations, and about how quickly price adjustmentsrestore match between aggregate supply and demand.
origins of shocks external to economy — nature, science, mistaken government policies
government part of problem, not solution
rational expectations and logical choices
ORIGINS AND RESPONSES TO BUSINESS CYCLES
in labour market, unemployment causes wages to fall, increasing hiring back to full employment
in output markets, prices fall due to surpluses and falling wage costs, increasing sales back to potential GDP
in loanable funds market, savings cause interest rates to fall, increasing investment spending (I), increasing Canadian real GDP and decreasing unemployment
origins of shocks internal to economy — changing expectations, role of money, connections with R.O.W.
volatile expectations based on fundamental uncertainty about future
facing uncertainty, saving decisions are internal negative demand shock
business cycles in other economies affect Canada through exports and imports
in labourmarket, wages sticky even with unemployment —layoffs instead of lower wages
in output markets, prices fall due to surpluses, but falling incomes from unemployment in input markets decrease consumption demand (C)
in international trade market, falling Canadian prices increase net exports, but destabilizing effects of cycles in R.O.W.
with weak/slow price adjustments, role for government to bring aggregate supply and aggregate demand back into balance
connections between input markets and output markets for both demand and supply sides
connections between Canada and R.O.W.
connections between money/banks/expectations and input and output markets