14 The Keynesian Cross Copyright 2021 McGraw-Hill Education To ponder upon… Do we use economics everyday? § How do your transaction at the store ad to the total Aggregate Demand in the economy? § Does fuel prices influence the quantity supplied? Copyright 2021 McGraw-Hill Education In this chapter you will learn: • Deriving the Aggregate Demand from the Aggregate Expenditure model • Aggregate Demand and the Factors That Cause it to Change • Aggregate Supply and the Factors That Cause it to Change • How AD and AS Determine an Economy’s Equilibrium Price Level and the Level of Real GDP • How the AD-AS Model Explains Periods of DemandPull Inflation, Cost-Push Inflation, and Recession • Investment-Savings schedule (IS) and Liquidity Money schedule (LM) Copyright 2021 McGraw-Hill Education Where from now? Aggregate Demand and Changes in AD Copyright 2021 McGraw-Hill Education Aggregate Supply and changes in AS Equilibrium Changes IS = LM Deriving the AD Curve Aggregate Expenditures (billions of rand) AE2 (at P2 ) AE3 (at P3 ) As Price Levels Increase… Price Level 45° P3 Real GDP Declines P2 P1 AD Q1 Copyright 2021 McGraw-Hill Education Q2 Q3 Real Domestic Product, GDP Deriving the AD Curve AE2 (at P1 ) Aggregate Expenditures AE1 (at P1 ) Increase in Aggregate Expenditures Price Level 45° Increase in Aggregate Demand P1 AD2 AD1 Q1 Q2 Real Domestic Product, GDP Copyright 2021 McGraw-Hill Education Deriving the AD Curve AE2 (at P1 ) Aggregate Expenditures AE1 (at P1 ) The Shift in the Aggregate Demand Curve is a Multiple of the initial Change in Aggregate Expenditures Price Level 45° P1 AD2 AD1 Q1 Q2 Real Domestic Product, GDP Copyright 2021 McGraw-Hill Education AD – AS Model • Aggregate DemandAggregate Supply Model (AD-AS Model) • Aggregate Demand • Why the Downward Slope? –Real-Balances Effect –Interest-Rate Effect –Foreign Purchases Effect Copyright 2021 McGraw-Hill Education AD – AS Model Price Level Aggregate Demand Curve Aggregate Demand AD Real Domestic Output, GDP Copyright 2021 McGraw-Hill Education Changes in Aggregate Demand • Determinants of Aggregate Demand and Multiplier Effect • Changes in: Copyright 2021 McGraw-Hill Education – Consumer Spending – Consumer Wealth – Consumer Expectations – Household Debt – Personal Taxes – Investment Spending – Real Interest Rates Changes in Aggregate Demand –Expected Returns • About Future Business Conditions • Technology • Degree of Excess Capacity • Business Taxes –Government Spending –Net Export Spending –National Income Abroad • Exchange Rates Copyright 2021 McGraw-Hill Education Changes in Aggregate Demand Changes in Aggregate Demand Curve Price Level Increase in Aggregate Demand Decrease in Aggregate Demand AD2 AD3 AD1 Real Domestic Output, GDP Copyright 2021 McGraw-Hill Education Aggregate Supply Aggregate Supply in the Long Run Price Level ASLR Long Run Aggregate Supply Real Domestic Output, GDP Copyright 2021 McGraw-Hill Education Aggregate Supply Aggregate Supply in the Short Run Per-Unit Production Cost Total Input Cost = Units of Output Price Level Aggregate Supply (Short Run) 0 Qf Real Domestic Output, GDP Copyright 2021 McGraw-Hill Education Changes in Aggregate Supply • Determinants of Aggregate Supply • Changes in: – Input Prices – Domestic Resource Prices – Prices of Imported Resources – Market Power – Productivity – Legal-Institutional Environment – Business Taxes and Subsidies – Government Regulation Copyright 2021 McGraw-Hill Education Changes in Aggregate Supply Understanding Productivity Productivity Total Output Total Inputs Copyright 2021 McGraw-Hill Education = = Total Output Total Inputs 10 5 = 2 Changes in Aggregate Supply Changes in Aggregate Demand Curve AS3 AS1 Decrease in Aggregate Supply Price Level AS2 Increase in Aggregate Supply Real Domestic Output, GDP Copyright 2021 McGraw-Hill Education Equilibrium and Changes in Equilibrium Tabular View… Real Output Demanded (Billions) Price Level (Index Number) Real Output Supplied (Billions) R506 108 R513 508 104 512 510 100 510 512 96 507 514 92 502 Equilibrium Price Level and Equilibrium Price Level Copyright 2021 McGraw-Hill Education Equilibrium and Changes in Equilibrium Price Level AS Equilibrium 100 92 a b AD 502 510 514 Real Domestic Output, GDP (Billions of rand) Copyright 2021 McGraw-Hill Education Equilibrium and Changes in Equilibrium Increase in Aggregate Demand Price Level AS Demand-Pull Inflation P2 P1 AD1 AD Qf Q1 Q2 Real Domestic Output, GDP Copyright 2021 McGraw-Hill Education Equilibrium and Changes in Equilibrium Decrease in Aggregate Demand Price Level AS P1 b a c P2 Creates a Creates a Recession Recession AD1 AD2 Q1 Q2 Qf Real Domestic Output, GDP Copyright 2021 McGraw-Hill Education Equilibrium and Changes in Equilibrium • Recession and Cyclical Unemployment • Deflation • Downward Price Inflexibility Due to: – Fear of Price Wars – Menu Costs – Wage Contracts – Morale, Effort, and Productivity • Efficiency Wages – Minimum Wage Copyright 2021 McGraw-Hill Education Equilibrium and Changes in Equilibrium Decrease in Aggregate Supply Price Level AS1 Cost-Push Inflation P2 P1 AS b a AD Q1 Qf Real Domestic Output, GDP Copyright 2021 McGraw-Hill Education Equilibrium and Changes in Equilibrium Increases in Aggregate Supply – Full-Employment With Price-Level Stability Price Level AS1 P3 P2 P1 AS2 b a c AD2 AD1 Q1 Q2Q3 Real Domestic Output, GDP Copyright 2021 McGraw-Hill Education Deriving the IS curve Copyright 2021 McGraw-Hill Education LM Curve (Money Market) Copyright 2021 McGraw-Hill Education IS / LM Curve equilibrium Copyright 2021 McGraw-Hill Education Last Word Lessons from Keynes in the age of Coronavirus Case Study Smith, Say’s Law and then Keynes Copyright 2021 McGraw-Hill Education Key Terms • • • • • • • • • • aggregate demandaggregate supply (ADAS) model aggregate demand real-balances effect interest-rate effect foreign purchases effect determinants of aggregate demand aggregate supply long-run aggregate supply curve Fiscal policy Monetary policy Copyright 2021 McGraw-Hill Education • • • • • • • • • • short-run aggregate supply curve determinants of aggregate supply productivity equilibrium price level equilibrium real output menu costs efficiency wages Interest rates Investment savings schedule Liquidity and Money schedule
