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3.3: Macroeconomic Models

3.3: Macroeconomic Models. Aggregate Demand Components. AD=C+I+G+X-M How does the AD curve (and diagram labels) differ from a simple demand curve?. P = GDP deflator (‘95=100) Q = GDP real. Why Does Aggregate Demand Slope Downward. Real Income Effect

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3.3: Macroeconomic Models

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  1. 3.3: Macroeconomic Models

  2. Aggregate Demand Components • AD=C+I+G+X-M • How does the AD curve (and diagram labels) differ from a simple demand curve?

  3. P = GDP deflator (‘95=100) • Q = GDP real

  4. Why Does Aggregate Demand Slope Downward • Real Income Effect • P Yreal C&I Q(AD) • Real Balance Effect • P S present C&I Q(AD) • International Substitution Effect • P(domestic) relative P(M) Q(M) Q(AD) • Imports become more expensive relative to domestic goods (substitution effect)

  5. Price Level and Interest Rates • Price Level (inflation) and Interest Rates • Positive correlation • Banks want to maintain real value of loans when inflation is increasing. • CAREFUL • Price Level Change= Interest Rate Change = Movement Along AD curve • Interest Rate Change (not because of Price Level Change) = Shift in AD curve

  6. r C& I AD shift

  7. Price Level and Real GDP Depression Region Bottlenecks Diminishing Returns Supply Constraints Scarcity of Factors Physical Limit Aggregate Supply- Short Run

  8. John Maynard Keynes The General Theory of Employment, Interest, and Money- 1936 Father of Macroeconomics Keynesian vs. Neo-classical Approach (Long Run)

  9. Neo-classical view • Microeconomic focus • Faith in markets to reach “equilibrium” in LR • Labor like any other commodity • Laissez-faire

  10. Keynesian Approach • Response to conditions seen during Great Depression • Sometimes markets don’t reach equilibrium. • Solution: Increase income and create demand • Demand-side policies • Government intervention/spending • Job creation

  11. Keynesian Criticism of Neo-classical view

  12. Inflationary Gap

  13. Deflationary Gap

  14. Business Cycle 4 Parts

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