Chapter 7: Aggregate Demand and Aggregate Supply Curve

1
Chapter 7Aggregate Demand and Aggregate
Supply Curve
2
Aggregate Demand (AD) Curve

• Amounts of Real GDP purchased at different
  P-levels (P)
• Recall Real GDP Total Expenditure (TE)
  C I G (EX - IM)
• AD shows TE levels at different Price levels

3
3 Reasons AD Curve Slopes Down

• Real Balance (Wealth) Effect
• P-level rises (falls), real income/wealth falls
  (rises), people buy less (more) goods
• Interest Rate Effect
• Prices increase, goods more expensive
• Consumers/firms borrow more for spending
• Higher demand for loanable raises interest
  rates, reduces borrowing and C I spending
• Opposite for Price decreases

4
3 Reasons AD Slopes Down (cont.)

• International Trade Effect
• As Domestic Prices rises, domestic goods more
  expensive relative foreign goods
• Domestic consumers buy more foreign goods
  (imports rise)
• Foreign consumers buy fewer domestic goods
  (exports fall)
• Result Net Exports decrease

5
Change in Quantity Demanded of Real GDP
Price Level (Index)

• Change in P, Change in Quantity Real GDP
• Along AD Curve
• Lower P, increased Real GDP
• Why?

P1
P2
AD

• Real GDP (Q)

Q1
Q2
6
Changes (Shifts) in AD Curve
Price Level (index)

• At given P, change in TE shifts AD curve
• TE CIG(EX - IM)
• TE increases, AD shifts right
• TE decreases, AD shifts left

P1

• B

• A

P2

• C

• D

AD2
AD1

• Real GDP (billion )

10
25
35
45
7
Changes (shifts) in AD (cont.)

• Factors Changing Consumption (C) Spending
• Wealth
• Expectations of Future Ps Income
• Interest Rates
• Taxes
• Factors Changing Investment (I) Spending
• Expectations of Future Sales
• Interest Rates
• Taxes

8
Changes in AD (cont.)

• Factors Changing Government (G) Spending
• Rise (fall) in G, raises (lowers) AD
• Factors Changing Net Exports (EX - IM)
• Foreign Real National Income
• Raises purchases of US goods exported
• Exchange Rate (Price of Foreign Currency)
• Appreciation (increase) in value, foreign goods
  relatively cheaper
• Depreciation (decrease) in value, foreign goods
  relatively more expensive

9
Illustration on Exchange Rates

• Exchange Rate of relative UK pound (L) is 2
  L1
• TV for L500 in UK costs 1,000
• Suppose Appreciates to 0.50 L1
• TV now costs 250, so increase purchases
• Appreciation in value, Foreign goods cheaper
• AD Shifts Left
• Depreciation in value, U.S. goods cheaper
• AD Shifts Right

10
Short-Run Aggregate Supply (SRAS) Curve

• Shows Real GDP firms produce at different
  P-levels
• Upward Sloping, at some point
• Price level rises, producers willing/able to sell
  more goods
• At some point, increased output means higher
  marginal costs

11
Changes (Shifts) in SRAS Curve

• Factors Changing Aggregate Supply, ceterus
  paribus
• Wages
• Price of Nonlabor Inputs
• Capital, Land, Intermediate goods
• Productivity
• Supply Shocks
• Adverse Shocks
• Beneficial Shocks

12
Changes (Shifts) in SRAS Curve
Price Level

• SRAS2
• Increased labor costs
• Increased nonlabor resource prices
• Lower productivity
• Adverse supply shock
• SRAS3
• Decreased wages
• Decreased nonlabor resource prices
• Higher productivity
• Positive supply shock

SRAS2
SRAS1
SRAS3
P1

• B

• A

• C

• Real GDP (billion )

Q2
Q1
Q3
13
Short-Run Equilibrium
Price Level

• Short-Run Equilibrium
• Point E at PE and QE
• PHigh
• Economy at Surplus (Q3-Q2)
• P and Q-supplied fall
• Consumer spending increases. Why?
• PLow
• Economy at Shortage (Q3-Q2)
• P and Q supplied rise
• Consumer spending falls

SRAS
PHigh
PE

• E

PLow
AD

• Real GDP (billion )

Q2
QE
Q3
14
Relation Between Real GDP and Unemployment Rate

• Real GDP increases, unemployment decreases,
  ceterus paribus
• Why?

15
Equilibrium Changes Decrease in SRAS
Price Level

• Causes of Change
• Adverse Supply Shock
• Increase in Labor Costs
• Lower productivity
• Increase in Nonlabor Resource Ps
• Effects
• P-Level Increases
• Real GDP Decreases
• Unemployment Increases

SRAS2
SRAS1
P2

• B

P1

• A

AD

• Real GDP (billion )

Q2
Q1
16
Equilibrium Changes Increase in SRAS
Price Level

• Causes of Change
• Positive Supply Shock
• Decrease in Labor Costs
• Higher productivity
• Decrease in Nonlabor Resource Ps
• Effects
• P-Level Decreases
• Real GDP Increases
• Unemployment Decreases

SRAS1
SRAS3
P1

• A

P2

• B

AD

• Real GDP (billion )

Q2
Q1
17
Equilibrium Changes Increase in AD
Price Level

• Causes of Change
• Any change in TE shifts AD curve
• What changes TE?
• Effects
• Price Level Rises
• Real GDP Rises
• Unemployment Decreases

SRAS
P2

• B

P1

• A

AD2
AD1

• Real GDP (billion )

Q2
Q1
18
Equilibrium Changes Decrease in AD
Price Level

• Causes of Change
• Any Decrease in TE shifts left AD
• Decrease in TE?
• Effects
• Price Level Decreases
• Real GDP Decreases
• Unemployment Increases

SRAS
P1

• A

P2

• B

AD1
AD2

• Real GDP (billion )

Q2
Q1
19
Possible Shapes of SRAS
Price Level

• Horizontal
• Recession/Depression
• Unemployed resources
• Increased output doesnt drive up resource Ps
• Upward Sloping
• Increased output raises resource costs
• Increase in AD raises P and Real GDP
• Vertical
• Changes in AD only change P-level

SRAS
P3
AD3
P2
P1
AD2
AD1

• Real GDP (billion )

Q1
Q2
QN