chapter 9 n.
Download
Skip this Video
Loading SlideShow in 5 Seconds..
CHAPTER 9 PowerPoint Presentation
Download Presentation
CHAPTER 9

Loading in 2 Seconds...

play fullscreen
1 / 54

CHAPTER 9 - PowerPoint PPT Presentation


  • 83 Views
  • Uploaded on

CHAPTER 9. COORDINATING ECONOMIC ACTIVITY: AGGREGATE DEMAND AND SUPPLY. ECONOMIC FLUCTUATIONS. Movements of GDP away from potential output; Also referred to as business cycles;. KEYNESIAN ECONOMICS. Models based on the idea that demand determines output in the short run;

loader
I am the owner, or an agent authorized to act on behalf of the owner, of the copyrighted work described.
capcha
Download Presentation

PowerPoint Slideshow about 'CHAPTER 9' - zared


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.While downloading, if for some reason you are not able to download a presentation, the publisher may have deleted the file from their server.


- - - - - - - - - - - - - - - - - - - - - - - - - - E N D - - - - - - - - - - - - - - - - - - - - - - - - - -
Presentation Transcript
chapter 9

CHAPTER 9

COORDINATING ECONOMIC ACTIVITY:

AGGREGATE DEMAND AND SUPPLY

economic fluctuations
ECONOMIC FLUCTUATIONS
  • Movements of GDP away from potential output;
  • Also referred to as business cycles;
keynesian economics
KEYNESIAN ECONOMICS
  • Models based on the idea that demand determines output in the short run;
  • Short run -- The period of time when prices are fixed;
real shocks to the economy
REAL SHOCKS TO THE ECONOMY

One cause of economic fluctuations :

  • Developing countries dependent on agriculture, which suffer loss to cash crop
  • Sharp increases in the price of oil can hurt modern economies
  • Wars can devastate entire regions of the world
  • Natural disasters can cause sharp reductions in GDP
  • Major shifts in technology leading to the birth of new industries have profound effects on the economy
real business cycle theory
REAL BUSINESS CYCLE THEORY
  • School of economic thought that emphasizes the role that shocks to technology can play in causing economic fluctuations
  • Led by Edward Prescott of the University of Minnesota
  • Developed models that integrate technology shocks into classical models
  • Changes in technology will usually change the level of full employment or potential output
  • It portrays economic fluctuations as movements in potential output, not as deviations away from potential output
slide6

INITIAL PATTERN OF DEMAND AND PRICES

Price

S

P0

D

Tennis Racquets

Quantity

Q0

slide7

INITIAL PATTERNS OF DEMAND AND PRICES

Price

Price

S

S

P0

P1

D

D

Tennis Racquets

Quantity

Roller blades

Quantity

Q0

Q1

slide8

DEMAND AND PRICES AFTER CHANGES IN TASTES

Price

Price

S

S

P1

PA

DB

D

D

DA

Tennis Racquets

Quantity

Roller blades

Quantity

QA

Q1

Suppose rollerblading starts to replace tennis. Demand shifts to DA in the

market in tennis racquets and DB in the market for roller blades.

slide9

DEMAND AND PRICES AFTER CHANGES IN TASTES

Price

Price

S

S

PB

P0

P1

PA

DB

D

D

DA

Tennis Racquets

Quantity

Roller blades

Quantity

QA

Q0

Q1

QB

Suppose rollerblading starts to replace tennis. Demand shifts to DA in the

market in tennis racquets and DB in the market for roller blades. Prices of

rollerblades will rise to PB, prices of tennis racquets will fall to PA.

prices and economic coordination
PRICES AND ECONOMIC COORDINATION
  • The change in tastes from tennis racquets to rollerblading has caused the economy to produce more roller blades and fewer tennis racquets
  • The economy accomplishes this through prices
  • When roller blading became more popular than tennis, the price of roller blades rose and the price of tennis racquets fell
  • The producers of roller blades were given a signal to step up production
  • The producers of tennis racquets were given a signal to cut back their production
  • Workers will leave tennis racquet industry to be employed by roller blade industry
future prices
FUTURE PRICES
  • There is no price for automobiles to be delivered five years from now, so automobiles do not receive any direct signals that consumers wish to purchase automobiles in the future
  • Only a few commodities, such as metals and certain agricultural commodities, can be traded for future delivery in worldwide markets
too little information
TOO LITTLE INFORMATION
  • Prices may not always contain all the information that producers need
  • What matters to any firm is the real price: its price relative to all other prices in the economy
  • Reality Principle: What matters to people is the real value or purchasing power of money or income, not its face value
too little information1
TOO LITTLE INFORMATION
  • Problems can occur if firms are uncertain about whether a change in their output price is an increase in the real price or only on the nominal or dollar price
  • If producers believe demand for their product has fallen, they will cut back production
  • If this happened throughout the economy, it would lead to a recession
sticky prices
“STICKY” PRICES
  • If prices are “sticky” or not sufficiently flexible, prices will not coordinate activity as efficiently
  • In modern economies, some prices are flexible, while others are not
  • Auction Prices -- those determined on nearly a daily basis
  • Prices for fresh fish, vegetables, and other food are very flexible
  • Custom Prices -- those that adjust rather slowly
  • Prices for industrial commodities, such as steel rods or machine tools, are custom prices
slide15

STICKY PRICES IN THE MARKET FOR TENNIS RACQUETS

Price

S

P0

E

D

Tennis Racquets

Quantity

Q0

slide16

STICKY PRICES IN THE MARKET FOR TENNIS RACQUETS

Price

S

F

P0

E

D

DA

Tennis Racquets

Quantity

Q0

slide17

STICKY PRICES IN THE MARKET FOR TENNIS RACQUETS

Price

S

F

P0

E

D

DA

Tennis Racquets

Quantity

Q0

slide18

STICKY PRICES IN THE MARKET FOR TENNIS RACQUETS

Price

S

F

P0

E

D

DA

Tennis Racquets

Quantity

Q0

When demand falls to DA, prices are sticky and remain at P0. The result

is unsold production measured by the distance between E and F.

wages
WAGES
  • Wages, the price of labor, adjust extremely slowly
  • Workers often have long-term contracts that do not allow wages to change at all during a given year
  • Even unskilled, low-wage workers are often protected from decreases in their wages by minimum wage laws
  • For most firms, wages are the single most important cost of doing business
  • If wages are sticky, their overall costs will be sticky
  • Stickiness of wages reinforces stickiness of prices
short run prices are sticky
SHORT-RUN PRICES ARE STICKY
  • Firms let demand determine level of output in the short run
  • Automaker may have higher demand if autos are popular or lower demand if autos are unpopular
  • Steelmaker who provides steel to automaker may provide more or less steel without adjusting price
  • The same principle applies to workers
  • During good times a company will employ many workers and may even require some to work overtime with no wage change
  • The short run in macroeconomics is the period when prices are fixed
long run prices
LONG-RUN PRICES
  • In the long run, price adjust fully to changes in demand
  • Over short periods of time, the presence of formal and informal contracts mean that demand will be reflected primarily in changes in output, not prices
aggregate demand
AGGREGATE DEMAND
  • The aggregate demand curve plots the total demand for GDP as a function of price level
  • The aggregate demand curve is downward sloping
  • As the price level falls, the total demand for goods and services increases
slide23

AGGREGATE DEMAND

Price Level

P

AD: aggregate demand

Real GDP, Y

The aggregate demand curve plots the total demand for real GDP as a

function of the price level. The aggregate demand curve slopes downward,

indicating that aggregate demand increases as the price level falls.

reality principle
REALITY PRINCIPLE

What matters to people is the real value or purchasing power of money or income, not its face value.

wealth effect
WEALTH EFFECT
  • Increase in spending that occurs because the real value of money increases when the price level falls
  • One of the key reasons that aggregate demand slopes downward
two other reasons why demand curve slopes downward
TWO OTHER REASONS WHY DEMAND CURVE SLOPES DOWNWARD
  • Interest rate effect

With a given supply of money in the economy, a lower price level will lead to lower interest rates

As interest rates fall, demand for investment goods in the economy increase.

  • Effects from international trade

In an open economy, a lower price level will mean that domestic goods become cheaper relative to foreign goods and demand for domestic goods will increase

shifts of aggregate demand
SHIFTS OF AGGREGATE DEMAND
  • At any price level, an increase in aggregate demand means that total demand for real GDP has increased, and the curve shifts to the right
  • Factors that decrease the aggregate demand will shift the aggregate demand curve to the left
  • At any price level, a decrease in aggregate demand means that total demand for real GDP has decreased
key factors that shift the aggregate demand curve
KEY FACTORS THAT SHIFT THE AGGREGATE DEMAND CURVE
  • Changes in the supply of money
  • Changes in taxes
  • Changes in government spending
  • other factors
changes in the supply of money
CHANGES IN THE SUPPLY OF MONEY
  • An increase in the supply of money in the economy will increase aggregate demand and shift the demand curve right
  • At any price level, a higher supply of money will mean more consumer wealth and an increased demand for goods and services
  • A decrease in the supply of money will decrease aggregate demand and shift the aggregate demand curve to the left
changes in taxes
CHANGES IN TAXES
  • A decrease in taxes will increase aggregate demand and shift the aggregate demand curve to the right
  • Lower taxes will increase income available to households and increase their spending on goods and services
  • Increases in taxes will decrease the aggregate demand and shift the aggregate demand curve left
changes in government spending
CHANGES IN GOVERNMENT SPENDING
  • An increase in government spending will increase aggregate demand and shift the aggregate demand curve right
  • Since the government is a source of demand for goods and services, higher government spending naturally leads to an increase in total demand for goods and services
  • Decreases in government spending will decrease aggregate demand and shift the curve to the left
other factors
OTHER FACTORS
  • Any change in demand from households, firms, or the foreign sector will also change aggregate demand
  • When shifts in aggregate demand are discussed, any changes that arise from movements in the price level are not to be included
factors that shift demand
FACTORS THAT SHIFT DEMAND

Factors That Increase Factors That Decrease Aggregate Demand Aggregate Demand

Decrease in Taxes Increase in Taxes

Increase in Decrease in Government Spending Government Spending

Increase in Money Decrease in Money Supply Supply

slide34

SHIFTING AGGREGATE DEMAND

Price Level

P

Original aggregate demand

Output, Y

slide35

SHIFTING AGGREGATE DEMAND

Price Level

P

Increased aggregate demand

Original aggregate demand

Output, Y

slide36

SHIFTING AGGREGATE DEMAND

Price Level

P

Increased aggregate demand

Original aggregate demand

Output, Y

Decreases in taxes, increases in government spending, or an increase in

the supply of money all shift the aggregate demand curve to the right.

slide37

SHIFTING AGGREGATE DEMAND

Price Level

P

Increased aggregate demand

Original aggregate demand

Decreased aggregate demand

Output, Y

Decreases in taxes, increases in government spending, or an increase in

the supply of money all shift the aggregate demand curve to the right.

slide38

SHIFTING AGGREGATE DEMAND

Price Level

P

Increased aggregate demand

Original aggregate demand

Decreased aggregate demand

Output, Y

Decreases in taxes, increases in government spending, or an increase in

the supply of money all shift the aggregate demand curve to the right.

Higher taxes, lower government spending, or a lower supply of money

shift the curve to the left.

aggregate supply
AGGREGATE SUPPLY
  • Depicts the relationship between the level of prices and real GDP
  • Two different aggregate supply curves, which correspond to the long run and the short run:

-- classical aggregate supply curve

-- Keynesian aggregate supply curve

classical aggregate supply curve
CLASSICAL AGGREGATE SUPPLY CURVE
  • Aggregate supply curve for the long run when the economy is at full employment
  • Full-employment output depends solely on the supply of capital and labor and the state of technology
  • full-employment output does not depend on the price level
  • Classical aggregate supply curve is plotted as a vertical line ( unaffected by prices )
slide41

CLASSICAL AGGREGATE SUPPLY

AS

p

Price

y *

Output,

y

In the long run, the level of output y* is independent of the price level.

slide42

AGGREGATE DEMAND AND

CLASSICAL AGGREGATE SUPPLY

p

Classical

AS

Price

Original AD

y *

Output,

y

Output and prices are determined at the intersection of AD and AS.

combining aggregate demand and aggregate supply
COMBINING AGGREGATE DEMAND AND AGGREGATE SUPPLY
  • The price level and level of output are determined by the intersection of aggregate supply and aggregate demand
  • At that point, total amount demanded will just equal the total amount supplied
  • The position of the aggregate demand curve will depend on the level of taxes, government spending, and the supply of money
  • The full-employment output determines the classical aggregate supply curve
slide44

AGGREGATE DEMAND AND

CLASSICAL AGGREGATE SUPPLY

p

Classical

AS

Price

Increased AD

Original AD

y *

Output,

y

Output and prices are determined at the intersection of AD and AS.

An increase in aggregate demand to a higher price level.

slide45

COMBINING AGGREGATE DEMAND AND AGGREGATE SUPPLY

  • An increase in demand will shift the aggregate demand curve right
  • With a classical aggregate supply curve, the increase in aggregate demand will raise the prices but leave the level of output unchanged
the keynesian aggregate supply curve
THE KEYNESIAN AGGREGATE SUPPLY CURVE
  • The Keynesian aggregate supply curve is horizontal in the short run
  • Firms are assumed to supply all output that is demanded at the current price
  • Formal and informal contracts commit producers to supply all that is demanded at the going price
  • The entire Keynesian supply curve can shift up or down as prices adjust to their long-run levels
slide47

KEYNESIAN AGGREGATE SUPPLY

p

Price

Keynesian AS

p0

Output,

y

slide48

AGGREGATE DEMAND AND

KEYNESIAN AGGREGATE SUPPLY

p

Price

E0

Keynesian AS

p0

Original AD

y 0

Output,

y

slide49

AGGREGATE DEMAND AND

KEYNESIAN AGGREGATE SUPPLY

p

Price

E0

E1

Keynesian AS

p0

Increased AD

Original AD

y 0

y 1

Output,

y

With a Keynesian aggregate supply curve, shifts in aggregate demand

lead to changes in output but no changes in prices.

aggregate demand and keynesian aggregate supply curves
AGGREGATE DEMAND AND KEYNESIAN AGGREGATE SUPPLY CURVES
  • The intersection of AD and AS curves determines the price level and the level of output at point E
  • Since aggregate demand is horizontal, aggregate demand totally determines the level of output
  • As aggregate demand increases, the new equilibrium will be at the same price p0, but output will increase from y0 to y1
  • The Keynesian aggregate supply curve need not correspond to full-employment output
  • Changes in demand will lead to economic fluctuations with sticky prices and a Keynesian aggregate supply curve
supply shocks
SUPPLY SHOCKS
  • External disturbances that shift the aggregate supply curve
  • Most important illustrations of supply shocks for the world economy have been sharp increases in the price of oil that occurred in 1973 and 1979
  • -- When oil prices increased sharply, firms would no longer sell all the goods and services that were demanded at the current price
  • -- To maintain their profit levels, firms raised their prices
slide52

A SUPPLY SHOCK

p

Price

AS (before the

shock)

p0

AD

y0

Output,

y

slide53

A SUPPLY SHOCK

p

Price

AS (after the

shock)

AS (before the

shock)

p0

AD

y0

Output,

y

An adverse supply shock, such as an increase in the price of oil, will

shift up the AS curve.

slide54

A SUPPLY SHOCK

p

Price

AS (after the

shock)

p1

AS (before the

shock)

p0

AD

y1

y0

Output,

y

An adverse supply shock, such as an increase in the price of oil, will

shift up the AS curve. The result will be higher prices and a lower level

of output.