13 aa Aggregate Demand and Aggregate Supply 1 Copyright ©2017 Cengage Learning. All Rights Reserved. May not be scanned, copied or duplicated, or posted to a publicly accessible website, in whole or in part. Aggregate Demand (AD) Aggregate demand Total demand for final goods & services in the economy. AD = C + I + G + NX There is a negative relationship between the quantity of RGDP demanded & the price level Copyright ©2017 Cengage Learning. All Rights Reserved. May not be scanned, copied or duplicated, or posted to a publicly acce ssible website, in whole or in part. SURVEY3 | CH13 2 Why the AD Curve Slopes Downward AD = C + I + G + NX A higher price level: 1. Wealth effect (C) Reduces the purchasing power of wealth; household consumption falls 2. Interest rate effect (I) Raises the interest rate, which discourages investment made by firms Why the AD Curve Slopes Downward AD = C + I + G + NX A higher price level: 3. International Trade Effect (NX) Reduces the competitiveness of domestically produced products • U.S. exports (X) fall; U.S. imports (M) rise • U.S. Net exports (X-M) and RGDP both fall. Slope of the AD Curve A higher price level lowers: C: Wealth effect I: Interest rate effect NX: international trade effect Shifts in the AD Curve An Increase in AD A Decrease in AD AD curve shifts leftward AD curve shifts rightward Shifts in AD are caused by a change in any non-price factor that: Increases: C, I, G or NX Decreases: C, I, G or NX Copyright ©2017 Cengage Learning. All Rights Reserved. May not be scanned, copied or duplicated, or posted to a publicly acce ssible website, in whole or in part. SURVEY3 | CH13 6 Shifts in Consumption (C) Changes in real wealth Consumer Confidence Changes in taxes & transfer payments Disposable income = income + transfers - taxes Shifts in Investment (I) General expectations about the future Investor or business confidence Interest rates Changes in monetary policy made by the Fed (money supply) Shifts in Government Purchases (G) Changes in Policy These changes may be made in response to economic conditions. • Increase in (G): AD curve shifts right • Decrease in (G) AD curve shifts left Shifts in International Trade Foreign income affects the demand for U.S. goods & services (exports) If foreign nations become wealthier: If foreign nations go into recession: • Demand for U.S. goods increases • Demand for U.S. goods decreases • NX increases and AD increases • NX decreases and AD falls Aggregate Supply (AS) Total supply of final goods & services in the economy Long run A period of time sufficient for all prices to adjusts (output prices and input prices) Short run A period of time in which some prices (primarily input prices) have not yet adjusted. The influence of the price level on AS depends on the time frame we are considering Long-Run Aggregate Supply (LRAS) LRAS is vertical at Y* • Y* is the natural level of output • U* is the natural rate of unemployment Structural + frictional unemployment Shifts in Long-Run AS An increase in productive capacity • More resources (land, labor, capital) • Better technology • Better institutions (growth promoting) Shifts in Long-Run AS A decrease in productive capacity • Fewer resources (land, labor, capital) • Worse technology • Worse institutions Short-Run AS Curve Why does the SRAS curve slope upward? Sticky Input (resource) Prices Resource prices Tend to be sticky b/c many are set by contract Output prices Are flexible (easier to change An Increase in the aggregate price level • Higher output price: increases firm revenues • Input prices: costs stay the same • Firms produce more Menu Costs Refers to the costs of changing prices Suppose the aggregate Price Level rises • If aggregate demand is rising the overall price level will increase • If a firm decides not to adjust its price because of menu costs, the firm will increase output to satisfy the higher demand Misperception Effects Firms and Workers make mistakes Suppose the aggregate Price Level FALLS • Firms may incorrectly interpret this economywide change as a relative price change and reduce output • Firms will also cut output if workers refuse a pay cut because they incorrectly interpret a decrease in dollar wages as a decrease in their real wage Shifts in Short-Run Aggregate Supply SRAS Shifts right: • If wages or other resource prices fall • If workers become more productive (temporarily) SRAS Shifts left: • If wages or other resource prices rise • If workers become less productive (temporarily) Supply Shocks An unexpected event that changes production costs temporarily Negative supply shock Positive supply shock raises production costs: SRAS shifts left lowers production costs: SRAS shifts right An Oil Embargo that cuts the world supply of Oil OPEC increases the world supply of Oil Permanent changes in oil production (Bakken, North Dakota) will shift both LRAS & SRAS to the right.
