3.4 Demand and
Supply Side Policies
3.4.1
Shift in Aggregate Demand
Demand Side Policies
 Shifting
the AD Curve (changes in
any components) C, I, G, X-M
– Expectations
 Inflationary
 Wealth
and Income
 Profit and Revenue
 Policy
 Overall Outlook
– International Issues
 Exhange
Rates
 Trading Partner’s Income
 Relative Prices
– Fiscal Policies
 Taxes
or Govt. Spending
– Monetary Policies
 Central
Bank
 Interest Rates and Money Supply
AD
Short Run Vs. Long Run
AD shift without
increase in LRAS is
INFLATIONARY
 A to B to C
 B: Real wages
drop, factor prices
increase (causes
supply shift)
 C: Inflationary
result

Overview of Demand
Management
 See
Chart pg.380
 Overheating vs. Recessionary
Economy
 Problem:
Fast rising inflation
 Solutions: Monetary?? Fiscal??
 Problem: High Unemployment
 Solutions: Mon.?? Fisc.??
Govt. Budgets
 Receipts
– Expenditures
 Which item under Receipts is the
biggest future problem?
 Surplus vs. Deficit
 National Debt vs. Foreign Debt
– Foreign = owed to other countries
Built-In Safety Nets vs.
Active Policies

Automatic-Stabilisers (Built-In Safety Net)
– Progressive Taxes
 Expansion:
> % income paid = less disposable
income= < Consumption = < AD
 Recession: < % income paid = > AD
– Social Benefits
 Expansion:
< Unemployment, Welfare =
Consumption = <AD
 Recession: > social spending = >AD
<
Both help to “soften” cycles, less volatile
Don’t solve or prevent cycles
Graphs pg. 383

Discretionary Fiscal Policies (Active)
– Govt. Spending
 Expansion:
Less spending < AD
 Recession: More spending > AD
 Focus on Unemployment
 Surpluses (Boom) used for > Spending during bad
times
Does this really happen?
– Taxes
 Expansion:
>Taxes =<C = <AD
 Recession: <Taxes = >C = >AD
Interest Rates and Monetary
Policy
 Definition:
– Real Interest = Nominal – Inflation
 Ex.
2% real = 5% nominal – 3%inflation
 Central
Bank
– Interest Rates
 Influence
C and I
 Inflation positively linked to interest rates
– Review pg. 346
 Used
to minimize inflation.
Functions of Central Bank
 Monetary
policy-
– interest rates, money supply
 Lender
of Last Resort
– To commercial banks
– Discount rate
 Key
for other rates
 Affects bank profit and lending rates
 Regulate
Lending
– Minimum reserve requirements

What could the Central Bank (Fed) do to
“tighten the money supply”?

When would the Fed do this?

Time Lags
– Fed must try to be forward thinking
– 2-6 quarters to influence inflation
– Up to 2yrs to affect AD
Relationship between Interest
and Investment
 Investment
Schedule
– Lower interest rates= Higher investment
– 1. Opportunity Costs
 Investment
costs fall
increases when opportunity
– 2. Cost of Investment
 Lower
rates = lower cost of borrowing
Supply and Demand for Money
pg. 388-389
Demand for Money
< Dm = shift left= lower r

– Caused by factors other than price (r)
 Ex.

Income levels, price levels (inflation)
Supply of Money
– Feds most common methods
 Discount
Rate
– Affects lending ability
 Open
Market Operations
– Buying and Selling of govt. debt
 Bills and Bonds
 Controls
on Bank Lending
– Reserve requirements
 Final
note from text:
– Basic Theory:
 Change
in Sm = Change in r
– Vice Versa
 Change
in r = Change in Sm
– Fed Can’t do Both simultaneously
Exchange Rate Policies
Can be influenced by Fed (rate change)
 Fed raises rates = greater demand for US
currency = > currency appreciation = < X
(US goods expensive) = >M (foreign
goods cheaper) = <AD


Falling r = falling currency value
– >exports
 (U.S.
goods cheaper for other countries)
– < imports
 (foreign

goods more expensive)
More on this in 4.6