
Aggregate demand: Schedule indicating spending plans of agents at alternative price levels.
0
Any factor that would shift the AE schedule will shift AD as well
AD
1
AD
2
Y

0
AD
1 to AD
2 due to:
•
Increase in income
• Increase in wealth
• Increase in consumer or business confidence
• Population growth
• Lower taxes
AD
1
AD
2
Y

0


AD
1
 to
 due to

The wealth effect.

The interest rate effect

The international trade effect .
The interest rate effect is poorly explained by Boyes
& Melvin on pp. 207-208
Y


Aggregate supply is the schedule indicating the quantity to total output supplied at alternative price levels
AS
1
AS
2
AS
1

AS
2 due to:
• Rising input prices
(wages, intermediate goods, raw materials)
•
Decreased productivity
0
Y

Productivity (

) means the average output of a worker per year, or alternatively:

= Y/N where N is total employment.
 depends on the efficiency with which labor is employed in the production of goods & services


Let
 denote average annual compensation of employees (including benefits). Thus unit labor cost (UCL) is defined as:
ULC =

/

Notice that compensation can rise with no effect on ULC, so long as productivity keeps pace

P
2
P
1
0
Y
1
AS
1
AS
2
An increase in ULC at every level of Y will shift
AS to the left
Y

AS

1

2
0
Notice that both Y and P increase
AD
2
AD
1
Y
Many economists think this accurately describes the U.S.
situation in 1966-68

P
2
P
1
0
LRAS
With the economy at full-employment, a change in
AD affects prices
--but not output, real income, or employment
AD
2
AD
1
Y* Y

P
2
P
1
0
AS
2
AS
1
Cost-push is a drag since
Y decreases and P increases
AD
Y
1
Y
2
Y

•
Grain failures
• Anchovies
• Oil shocks
• Wage and salary pressures
Stagflation is the simultaneous presence of high inflation and unemployment

Date
Jan. 1972
Dec. 1973
Price ($)
1.79
4.68
Jan. 1974 10.84
April 1979 14.55
June 1979 18.00
Nov 1979 24.00
Aug. 1980 30.00
Oct. 1981 34.00
Price of One Barrel of 34 0 crude oil
I’d call that a shock, wouldn’t you? The story of Joseph (see Old Testament) suggests buffer stocks as the remedy for supply-shock inflation
Source: The Petroleum Economist

Source: Economic Report of the President
Productivity and Costs, 1974-83
120
100
80
60
40
20
0
74 75 76 77 78 79 80 82 83
Productivity 93.2 95.1 97.9 99.7 101 99.5 99.2 100 102
Compensation 49.9 54.8 59.7 64.5 70.1
77 85.1 100 104
Unit Labor Cost 53.5 57.6
61 64.7 69.7 77.4 85.6 100 101
1982=100