12
Aggregate Demand and Aggregate
Supply
McGraw-Hill/Irwin
Copyright © 2012 by The McGraw-Hill Companies, Inc. All rights reserved.
Aggregate Demand
• Real GDP desired at each price level
• Inverse relationship
• Real balances effect
• Interest effect
• Foreign purchases effect
LO1
12-2
Price level
Aggregate Demand
AD
0
LO1
Real domestic output, GDP
12-3
Changes in Aggregate Demand
• Determinants of aggregate demand
• Shift factors affecting C, I, G, Xn
• 2 components involved
• Change in one of the determinants
• Multiplier effect
LO1
12-4
Price level
Changes in Aggregate Demand
AD2
AD3
AD1
0
Real domestic output, GDP
LO1
12-5
Consumer Spending
• Consumer wealth
• Household borrowing
• Consumer expectations
• Personal taxes
LO1
12-6
Investment Spending
• Real interest rates
• Expected returns
• Expectations about future business
conditions
• Technology
• Degree of excess capacity
• Business taxes
LO1
12-7
Government Spending
• Government spending increases
• Aggregate demand increases (as
•
LO1
long as interest rates and tax rates
do not change)
• More transportation projects
Government spending decreases
• Aggregate demand decreases
• Less military spending
12-8
Net Export Spending
• National income abroad
• Exchange rates
• Dollar depreciation
• Dollar appreciation
LO1
12-9
Aggregate Supply
• Total real output produced at each
•
LO2
price level
Relationship depends on time horizon
• Immediate short run
• Short run
• Long run
12-10
AS: Immediate Short Run
Price level
Immediate-short-run
aggregate supply
P1
0
ASISR
Qf
Real domestic output, GDP
LO2
12-11
Aggregate Supply: Short Run
AS
Price level
Aggregate supply
(short run)
0
Qf
Real domestic output, GDP
LO2
12-12
Aggregate Supply: Long Run
Price level
ASLR
Long-run
aggregate
supply
0
Qf
Real domestic output, GDP
LO2
12-13
Changes in Aggregate Supply
• Determinants of aggregate supply
• Shift factors
• Collectively position the AS curve
• Changes raise or lower per-unit
production costs
LO2
12-14
Changes in Aggregate Supply
AS3
AS1
Price level
AS2
0
Real domestic output, GDP
LO2
12-15
Input Prices
• Domestic resource prices
• Labor
• Capital
• Land
• Prices of imported resources
• Imported oil
• Exchange rates
LO2
12-16
Productivity
• Real output per unit of input
• Increases in productivity reduce
costs
• Decreases in productivity increase
costs
Productivity
=
Per-unit production cost
LO2
total output
total inputs
=
total input cost
total output
12-17
Legal-Institutional Environment
• Legal changes alter per-unit costs of
output
• Taxes and subsidies
• Extent of government regulation
LO2
12-18
Price level (index numbers)
Equilibrium
AS
100
a
92
b
Real Output
Demanded
(Billions)
Price Level
(Index Number)
Real Output
Supplied
(Billions)
$506
108
$513
508
104
512
510
100
510
512
96
507
514
92
502
AD
0
502
510 514
Real domestic output, GDP
(billions of dollars)
LO3
12-19
AD Increases: Demand-Pull Inflation
Price level
AS
P2
P1
AD2
AD1
0
Qf
Q1 Q2
Real domestic output, GDP
LO4
12-20
Decreases in AD: Recession
Price level
AS
P1
P2
b
a
c
AD1
AD2
0
Q1 Q2 Qf
Real domestic output, GDP
LO4
12-21
Decreases in AD: Recession
• Prices are downwardly inflexible
• Fear of price wars
• Menu costs
• Wage contracts
• Efficiency wages
• Minimum wage law
LO4
12-22
Decreases in AS: Cost-Push Inflation
Price level
AS2
AS1
b
P2
P1
a
AD
0
Q1 Qf
Real domestic output, GDP
LO4
12-23
Increases in AS: Full-Employment
Price level
AS1
P3
P2
P1
AS2
b
c
a
AD2
AD1
0
Q1
Q2 Q3
Real domestic output, GDP
LO4
12-24
Impact of Oil Prices Diminished?
• 1970’s
• Reduced AS and negative GDP gap
• Cost-push inflation
• Rising unemployment
• 2000’s
• Core inflation steady
• Use 50% less oil and gas today
• Federal Reserve more vigilant
12-25
Stagflation is a
combination of
recession (falling real
GDP) and inflation. Now
we will show how
stagflation could be
produced by a supply
shock
Inflation-Unemployment pairs for the U.S., 1960-89
16
www.bls.gov
14
80
12
7479
81
10
75
78
8
69
6
66
67
65
2
82
76
89
88 71
87
72
68
4
77
73
70
64
84
85
83
86
60
6263
61
0
3
4
5
6
7
Unemployment Rate
8
9
10
Price per barrel of 320 crude oil
Date
Jan. 1972
Dec. 1973
Jan. 1974
April 1979
June 1979
Nov 1979
Aug. 1980
Oct. 1981
Price ($)
1.79
4.68
10.84
14.55
18.00
24.00
30.00
34.00
• Anchovies
• Grain failures
Source: Petroleum Economist
Stagflation due to oil price shock
Buffer Stock
program
Story of Joseph
Price Level
AS0
AS1
115
110
AD
0
9.75
10.0
Real GDP