Macro Chapter 10
Dynamic Change, Economic
Fluctuations, and the AD-AS
Model
4 Learning Goals
1) Examine the factors that shift aggregate
demand
2) Examine the factors that shift short-run and
long-run aggregate supply
3) Analyze the impact of unanticipated changes
in aggregate demand and short run aggregate
supply
4) Consider whether market forces will return the
economy to equilibrium without government
intervention
It’s important to remember what we’re doing
We are using a model of the economy (the
AD-AS model) to begin to explain and
understand the business cycle
The actual economy is very complex and
internationally integrated
This is a principles class- not an advanced
theory class
Anticipated and
Unanticipated Changes
People react and behave differently to
events that are foreseen (anticipated) and
events that are surprising (unanticipated)
Factors that Shift
Aggregate Demand
Recall two things:
(1) Chapter 3 – change in demand
vs. change in quantity demanded
(2) Chapter 9 – four key markets
Remember circular flow diagram- four key
markets are connected; a change in one
will impact the others
Don’t memorize lists from the book
Think about changes in the world that will
cause lots of consumers to change their
behavior; i.e. buy more or buy less
Q10.1 (MA) If Asian economies suffer a serious
economic slump,
1. US net exports will rise
2. US net exports will fall
3. AD will shift right
4. AD will shift left
5. US unemployment will rise
6. US unemployment will fall
Q10.2 Which of the following will most likely
increase aggregate demand?
1.
2.
3.
4.
a decrease in stock market prices
a lower real interest rate
a decrease in the expected inflation rate
a decrease in real GDP
6 factors that shift AD listed in text:
1)
2)
3)
4)
5)
6)
Changes in real wealth
Changes in the real interest rate
Change in expectations
Change in the expected rate of inflation
Changes in incomes abroad
Changes in exchange rates
Shifts in Aggregate
Supply
Remember to distinguish between
the short run and the long run
For the long run, think about capacity
(What are we able to produce or how
much can we produce? Also remember
shifting the PPC)
For the short run, think about profits
Q10.3 (PMA) If an improvement in the quality of
education in the United States increases the
productivity of labor, this will
1. Increase SRAS
2. Decrease SRAS
3. Increase LRAS
4. Decrease LRAS
Q10.4 Other things constant, an increase in
resource prices will
1. decrease short-run aggregate supply.
2. increase short-run aggregate supply.
3. decrease long-run aggregate supply.
4. increase long-run aggregate supply.
Factors that shift SRAS:
1) Changes in resource prices
2) Changes in the expected rate of inflation
3) Supply shocks
Factors that shift LRAS:
1) Changes in the resource base
2) Changes in technology
3) Changes in institutional arrangements
(i.e. the “rules”)
Steady Economic Growth
and Anticipated Changes in
Long-Run Aggregate Supply
Steady economic growth is
desirable because:
(1) Output growth leads to income growth
(2) People will make better decisions than
if faced with highly variable changes
(3) More people will be employed
Unanticipated Changes
And Market Adjustments
Surprising events happen all the
time. This section addresses
how the economy reacts to such
changes.
The reactions are multiple-step processes
that usually involve all four key markets
What if AD surprisingly increases?
(1) Firms will increase production (move along
SRAS)
– Actual output > potential output
– Actual unemployment < natural rate
(2) Resources prices will begin to rise
(3) Interest rates will rise as demand for
loanable funds increases
(4) Foreigners will purchase more US assets;
the dollar will appreciate
(5) SRAS will begin to fall (shift left) and
consumers will buy less (move along AD)
(6) The economy will return to long run
equilibrium
What if AD surprisingly decreases?
(1) Firms will decrease production (move along
SRAS)
– Actual output < potential output
– Actual unemployment > natural rate
(2) Resources prices will begin to fall
(3) Interest rates will fall as demand for loanable
funds decreases
(4) Foreigners will purchase fewer US assets;
the dollar will depreciate
(5) SRAS will begin to rise (shift right) and
consumers will buy more (move along AD)
(6) The economy will return to long run
equilibrium
Summary Points:
Generally, if AD increases, then SRAS will
eventually decrease
Generally, if AD decreases, then SRAS
will eventually increase
Sometimes a change in AD is temporary
and will quickly move back to its original
position so SRAS need not change
Q10.5 Which of the following will most likely occur as the
result of an unanticipated increase in aggregate demand
that pushes output beyond long-run capacity?
1.
2.
3.
4.
An increase in the unemployment rate.
An increase in the real interest rate.
A decrease in resource prices
An appreciation of the dollar
Q10.6 (MA) Which of the following will most likely
accompany an unanticipated increase in aggregate demand?
1.
2.
3.
4.
5.
6.
a decrease in resource prices
an increase in resource prices
a decrease in real GDP
an increase in real GDP
the dollar will appreciate
the dollar will depreciate
What if SRAS surprisingly changes?
You must first ask yourself, is the change
temporary or permanent?
If temporary, then SRAS will shift back; no
change in LRAS
If permanent, then SRAS will shift and
stay; LRAS will also shift
Q10.7 (MA) For an oil-importing country such as
the United States, the effects of a supply shock
caused by an increase in the price of imported oil
would tend to be
1.
2.
3.
4.
an increase in real output.
a decrease in real output.
a decrease in resource prices.
an increase in resource prices.
Q 10.8 In the aggregate demand/aggregate supply model,
when the output of an economy is less than its long-run
potential, the economy will experience
1. declining real wages and interest rates that will
stimulate employment and real output.
2. rising interest rates that will stimulate aggregate
demand and restore full employment.
3. a budget surplus that will stimulate demand and,
thereby, help restore full employment.
4. rising real wages and real interest rates that will restore
equilibrium at a higher price level.
Key Points:
The U.S. economy is large and complex. It’s affected by
billions of people and worldwide events.
“Real” changes such as exchange rates, resources
prices, and interest rates are important.
Expectations, sentiment, and the political climate are
factors that are impossible to measure but critical to
decision-making and economic outcomes.
Cause and effect relationships are difficult to identify.
Ceteris paribus is difficult to use.
Unanticipated Changes,
Recessions, and Booms
Will the economy move from a
disequilibrium point back to longrun equilibrium “on its own”?
That is, does the economy have a “selfcorrecting mechanism”?
Arguably yes
The four key markets are tightly connected such
that a change in one market will cause a
reaction in another market
2 Key Components:
(1) Interest rate changes are key incentives
– Higher (lower) interest rates cause less (more)
consumption and investment
(2) Resource price changes redirect production
– Higher (lower) resource prices in one market will
lower (raise) production there and increase
(decrease) production somewhere else
The big question is, how quickly does it
work?
– If it works slowly, something else must be
done to restore long run equilibrium (fiscal
and monetary policy, i.e. stimulus)
– If it works quickly, then nothing else needs to
be done
Question Answers
10.1 = 2, 4, 5
10.2 = 2
10.3 = 1, 3
10.4 = 1
10.5 = 2
10.6 = 2, 4, 6
10.7 = 2, 4
10.8 = 1