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Chapter 13. Aggregate Demand and Aggregate Supply. Aggregate Demand Aggregate Supply. Aggregate Demand. Aggregate demand is the quantity of real goods and services that will be demanded at various price levels over a specific time period

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chapter 13

Chapter 13

Aggregate Demand and

Aggregate Supply

slide2
Aggregate Demand
  • Aggregate Supply
aggregate demand
Aggregate Demand
  • Aggregate demand is the quantity of real goods and services that will be demanded at various price levels over a specific time period

aggregate demand = consumption + investment + government + net exports

aggregate demand1
Aggregate Demand
  • Consumption demand originates with the household sector
    • directly related to income and inversely related to interest rates
  • Investment emanates from the business and household sectors
    • directly related to income and inversely related to the interest rate
aggregate demand2
Aggregate Demand
  • Government demand includes only purchases of goods and services
    • transfer payments are not included
    • determined by complex political decision-making process that includes both Congress and the President
aggregate demand3
Aggregate Demand
  • Net exports are the difference between exports and imports
    • inversely related to the exchange rate and to capital inflows
the aggregate demand curve
The Aggregate Demand Curve
  • There is an inverse relationship between the aggregate quantity of real goods and services demanded and the overall price level
  • 总需求曲线:其他条件不变时,总物价水平与实际产出的需求数量负相关;用与各种物价水平下一一对应的需求量描点作图而得出的曲线。
the aggregate demand curve1

1.05

1.00

.95

AD

$1,300 $1,500 $1,700

The Aggregate Demand Curve

Price Index

Real GDP (in Billions)

the aggregate demand curve2
The Aggregate Demand Curve
  • Along a particular aggregate demand curve, all factors besides the price level and the quantity of real goods and services demanded are held constant including:
    • the nominal money supply
    • expectations about future economic conditions
    • interest rates
    • taxes
    • government purchases
the aggregate demand curve3
The Aggregate Demand Curve
  • There are three reasons why economists believe that aggregate demand is downward sloping
    • wealth (real balances) effect
    • substitution-of-foreign goods effect
    • constant-nominal-income effect
the wealth real balances effect
The Wealth (Real Balances) Effect
  • When the overall price level changes for a given money supply, the supply of real money balances changes
    • spending units will experience a change in wealth
  • This leads to an inverse relationship between the price level and real GDP
the substitution of foreign goods effect
The Substitution-of-Foreign-Goods Effect
  • When the overall price level changes, domestic goods and services become relatively more or less expensive than foreign goods
    • this can lead to changes in net exports
  • Thus, there is an inverse relationship between the domestic price level and the aggregate quantity of real GDP demanded
the constant nominal income effect
The Constant NominalIncome Effect
  • By the equation of exchange, nominal income is equal to the overall price level multiplied by real GDP
    • when the price level changes, it will have an inverse effect on the aggregate quantity demanded of real GDP
why the aggregate demand curve slopes downward
Why the Aggregate Demand Curve Slopes Downward

Price Index

1. The Wealth or Real Balances Effect

2. The Substitute-of-Foreign-Goods Effect

3. The Constant Nominal Income Effect

Real GDP

the aggregate demand curve4
The Aggregate Demand Curve
  • When aggregate demand changes, the entire set of relationships between the various price levels and the quantities demanded at those prices changes
  • The entire aggregate demand curve shifts
    • if aggregate demand rises, the aggregate demand curve shifts to the right
    • if aggregate demand falls, the aggregate demand curve shifts to the left
a shift in the aggregate demand curve

A'

AD'

$2,000

A Shift in the AggregateDemand Curve

Price Index

A

1.0

AD

$1,500

Real GDP (in Billions)

what causes aggregate demand to change
What Causes Aggregate Demand to Change?
  • Aggregate demand changes when any of its components changes due to changes in
    • taxes
    • government spending
    • the money supply
    • interest rates
    • expected inflation
    • the economic outlook
    • exchange rates
what causes aggregate demand to change1
What Causes Aggregate Demand to Change?
  • Monetary and fiscal policies can and do cause aggregate demand to fluctuate
    • therefore these policies also affect the financial system (through interest rates and stock prices), international competitiveness (through the exchange rate), income, and expectations of future economic and financial developments
a schematic overview of the movements in aggregate demand

Monetary

Policy

Fiscal

Policy

Foreign Policy and Developments

Exchange Rates Capital Flow

Money Supply

Interest Rates

Government Spending & Taxes

Interest Rates, Stock Prices, Exchange Rates, Expected Inflation, Economic Outlook

Consumption

Government

Investment

Net Exports

Aggregate Demand and Income

A Schematic Overview of the Movements in Aggregate Demand
aggregate supply
Aggregate Supply
  • At the level of an individual firm, supply is simply the level of production planned by the firm at various prices per unit over a specified period of time
    • the firm compares the price of its output relative to the expected costs of production
    • relative prices play a key role in the firm’s production decisions
      • anything that alters a firm’s relative price will alter the quantity produced by the firm
aggregate supply1
Aggregate Supply
  • There is a direct relationship between price and quantity supplied
  • But what about a supply curve for the aggregate economy?
  • The aggregate supply curve for the economy as a whole depicts the level of output all firms will produce at various price levels over a period of time

总供给曲线:其他条件不变时,总物价水平与实际GD[的总量负相关;用于各种物价水平下一一对应的实际GDP产出量描点作图而得出的曲线即为总供给曲线。

aggregate supply2
Aggregate Supply
  • There is a direct relationship between price and quantity supplied
  • But what about a supply curve for the aggregate economy?
  • The aggregate supply curve for the economy as a whole depicts the level of output all firms will produce at various price levels over a period of time
    • different curves for the short and long run
short run aggregate supply
Short-Run Aggregate Supply
  • Suppose that the economy is in long-run equilibrium
    • all prices and wages and quantities in the economy have fully adjusted to previous shifts in aggregate demand or supply
    • the configuration of interest rates, exchange rates, expectations, and relative prices will continue until something else changes
short run aggregate supply1
Short-Run Aggregate Supply
  • Now, suppose that the Fed makes substantial open market purchases
    • the money supply rises and interest rates fall
    • aggregate demand rises
short run aggregate supply2
Short-Run Aggregate Supply
  • How will firms respond?
    • inventories will unexpectedly fall and there will be upward pressure on the firms’ output prices
      • firms will increase production
    • to increase production, firms will need additional inputs
      • since we started at full employment, the nominal wage will have to rise
short run aggregate supply3
Short-Run Aggregate Supply
  • Thus, the short-run effects of the increase in aggregate demand will be an increase in the price level and an increase in output and employment
  • The quantity of goods and services supplied rises when the price level rises
  • The short-run aggregate supply curve will be upward sloping
short run aggregate supply4
Short-Run Aggregate Supply

Price Index

SRAS

B

1.05

1.00

.95

A

C

AD

AD

AD

$1,300 $1,500 $1,700

Real GDP (in Billions)

long run aggregate supply
Long-Run Aggregate Supply
  • An economy’s natural level of output is determined by the quantity and productivity of its factors of production

自然产出水平:给定经济中生产要素的数量与生产率,与长期均衡相适应的实际产出水平。

    • capital stock
    • natural resources
    • labor force
  • It is the level of output to which an economy will move, given its factors of production and technology
determinants of the natural level of real output

Capital Stock

Natural resources

Labor force

Technological know-how

Institutional arrangements of the labor market and other input markets

Determinants of the Natural Level of Real Output

Natural Level of Real Output

long run aggregate supply1
Long-Run Aggregate Supply
  • The actual level of output can be greater than the natural rate in the short run
    • firms may respond to an increase in demand by operating overtime using standby plant capacity and employing more workers than usual
    • more workers may accept jobs because they mistake a rise in nominal wages for an increase in the real wage
long run aggregate supply2
Long-Run Aggregate Supply
  • The actual level of output can be lower than the natural rate in the short run
    • firms may respond to a decrease in demand by leaving plant capacity idle and laying workers off
long run aggregate supply3
Long-Run Aggregate Supply
  • A level of output that differs from the natural rate is not sustainable over time
  • An economy is in long-run equilibrium only when output prices are consistent and sustainable relative to input prices
    • actual values are equal to expected values
    • no unexpected changes in inventories or production
long run aggregate supply4
Long-Run Aggregate Supply
  • Suppose that, due to an increase in aggregate demand, prices are expected to rise by 10%
    • in the long run, input prices will rise proportionately to maintain the real incomes of the suppliers of the factors of production
    • there will be no incentive for firms to produce more or for workers to work more
    • output stays at its natural rate
long run aggregate supply5
Long-Run Aggregate Supply
  • The long-run aggregate supply curve will be vertical at the natural rate of output
long run aggregate real supply

B

1.00

AD'

Long-Run Aggregate Real Supply

LRAS

Price Index

1.00

A

AD

Real GDP

the relationship between the short run and the long run
The Relationship between the Short Run and the Long Run
  • Suppose that the economy is in long-run equilibrium
    • the actual price level is 1.00
    • the economy is operating at its natural rate of output ($1,500 billion)
shifts in short run aggregate supply
Shifts in Short-RunAggregate Supply

LRAS

Price Index

SRAS

A

1.00

AD

$1,500

Real GDP

the relationship between the short run and the long run1
The Relationship between the Short Run and the Long Run
  • Suppose there is an unexpected increase in the money supply
    • aggregate demand rises
    • firms experience unexpected declines in inventories and an increase in output price
    • firms expand employment and production
      • the price level rises to 1.05
      • output rises to $1,700 billion
shifts in short run aggregate supply1

B

1.05

AD’

$1,700

Shifts in Short-RunAggregate Supply

LRAS

Price Index

SRAS

A

1.00

AD

$1,500

Real GDP

the relationship between the short run and the long run2
The Relationship between the Short Run and the Long Run
  • The economy is now in short-run equilibrium, but not long-run equilibrium
    • the actual price level > the expected price level
    • workers have actually experienced a decline in real income and will seek an increase in their nominal wage
    • with employment up, labor markets will be tight and input prices will rise
    • short-run aggregate supply will shift left
the relationship between the short run and the long run3
The Relationship between the Short Run and the Long Run
  • Firms and input suppliers have based their expectations about future prices on the current price level (1.05)
    • this is why SRAS intersects LRAS at a price level of 1.05
shifts in short run aggregate supply2

SRAS’

B

1.05

AD’

$1,700

Shifts in Short-RunAggregate Supply

LRAS

Price Index

SRAS

C

A

1.00

AD

$1,500

Real GDP

the relationship between the short run and the long run4
The Relationship between the Short Run and the Long Run
  • The higher input prices lead firms to produce less (point C)
  • But the actual price level is still higher than the expected price level (at point C)
    • there will be additional adjustments in price expectations, input prices and firms’ production decisions
    • the SRAS curve will continue to shift left until long-run equilibrium is established
shifts in short run aggregate supply3

SRAS’’

D

1.10

B

1.05

AD’

$1,700

Shifts in Short-RunAggregate Supply

LRAS

Price Index

SRAS’

SRAS

C

A

1.00

AD

$1,500

Real GDP

the relationship between the short run and the long run5
The Relationship between the Short Run and the Long Run
  • The end result of the increase in demand is
    • a short-run rise in employment, output, and the price level
    • a long-run rise in the price level
  • This is a case of demand-pull inflation
    • demand increases and “pulls up” the price level

需求拉动型通货膨胀:较高的需求水平导致的价格水平的持续增长。

the relationship between the short run and the long run6
The Relationship between the Short Run and the Long Run
  • From a policymaker’s perspective, the short-run equilibrium is attractive but the long-run situation is much less attractive
    • if policymakers are nearsighted, they may focus on the short-run effects of policy