The Macro Model
National Income
Chapter 10
Apple CEO Steve Jobs
Graphing the Macro Model

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The vertical axis of the
measures the Price
Level, rather than Price
in the Micro Model
The horizontal axis of
the measures Real
GDP, rather than
quantity of micro model
Price Level = PL
Real GDP = RGDP
Long Run Aggregate Supply

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The Long Run Aggregate
Supply curve represents an
economy where all inputs:
land, labor and capital are
used to their fullest
efficiency
The Long Run Aggregate
Supply Curve = LRAS
It is similar to the
productions possibilities
frontier on a production
possibilities graph
Real GDP or National Income
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The LRAS represents
the economy running at
“full employment” or
the maximum level of
national income.
The LRAS often uses Y
to represent “full
employment” RGDP or
maximum National
Income
Growth
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The LRAS may shift to
the right indicating that
there has been
economic growth of real
GDP
This is similar to the
shift out in the
production possibilities
graph
Increases in the LRAS
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Growth created with the
LRAS leads to
increases in RGDP and
decreases in price
levels
This is a good situation
for an economy when it
can grow without price
rises.
RGDP Contractions
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The LRAS may also
shrink with a real GDP
contraction
This is indicated by the
LRAS shifting to the left
This type of shift is
called a supply shock
Decreases in the LRAS
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Decreases in the LRAS
can leads to decreases
in Real GDP and
increases in Price
Levels
This type of inflation is
called cost push
inflation
What are the four components
of Aggregate Demand?
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C = Consumption
I = Business Investment
G = Government Spending
NX= Net Exports = exports imports
Aggregate Demand
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The macro model has a
downward sloping
aggregate demand
curve
The Aggregate
Demand = C+I+G+(NX)
Aggregate Demand is
abbreviated AD
The place where the
AD intersects the LRAS
is the price level
Increases in Aggregate
Demand
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Increases in Aggregate
demand lead to increases in
price levels, however with
the LRAS there is no
change in RGDP
These increases are called
demand pull inflation
This type of inflation is
common during period of
economic expansions
Decreases in Aggregate
Demand
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Decreases in
Aggregate Demand
lead to lower price
levels, however real
GDP does not change
Real GDP
Decreases in aggregate
demand commonly
occurs during a
contraction or recession
What happens to RGDP if price
levels fall?

If price levels fall the
RGDP will rise
What happens to RGDP if price
levels rise?

If price levels rise the
RGDP will fall
Why does the AD curve slope
down?

Wealth Effect -(also
called Real Balance
Effect) if price level
rises, people’s
purchasing power goes
down and if price levels
fall people’s
purchasing power goes
up
Why does the AD curve slope
down?
Interest Rate Effect - if
prices rise the real
value of money goes
down, therefore the
demand to borrow
money increases,
driving up interest
rates. Conversely if
prices fall, interest rates
fall.
Why does the AD curve slope
down?
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Open Economy Effect if price levels go up our
net exports drop; if
price levels goes down
our net exports
increase
What causes increases and
decreases Aggregate Demand
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Changes in price levels lead
to changes in real GDP
There are a variety of nonprice factors which can shift
the Aggregate Demand
curve up and down.
Look at the following
examples, and figure out
whether they will increase
or decrease AD
People begin buying more
food, clothing, and cars
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Aggregate demand will rise
The federal government
reduces military spending

Aggregate demand will fall
Sales tax is eliminated in
California

Aggregate demand will rise
Foreign countries buy more
US exports

Aggregate demand will rise
The money supply decreases

Aggregate demand will decrease
The US dollar becomes
stronger compared to the Euro

Aggregate demand will fall
The Federal Reserve Bank
raises interest rates

Aggregate demand will fall
A US company sells a jet to a
foreign country

Aggregate Demand will rise
A US company buys coffee
beans from Guatemala
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Aggregate demand will fall
A drop in the value of the
dollar
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Aggregate demand will increase
The Federal reserve restricts
the money supply

Aggregate demand falls
Interest rates fall

Increase in aggregate demand
Europe and Japan suffers from
a Depression

Aggregate Demand falls
China grows rapidly, and buys
high tech US products

Aggregate Demand rises
Shifts in Long Run Aggregate
Supply Curve
Which side are you on?
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Consumer spending increases
AD
New inventions boost solar energy
AS
Government cuts back on military budget
AD
Government raises the retirement age on workers
AS
Business investment increases
AD
Which side are you on?
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Retraining of US workers make them more
productive
AS
New shale oil is discovered in the Rockies
AS
Modern Macro Model with Short Run
Aggregate Supply Curve
Short Run Aggregate Supply
Curve
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The short run aggregate supply curve or
(SRAS) can shift when there are temporary
efficiencies in capital, labor, and land
For example, plants can run at more than a
100% capacity, when they run at night.
Workers can work overtime, thus increasing
the productivity of labor
Shifts in the short run
Aggregate Supply
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Short run increases in the supply curve is the
result of:
Labor working overtime
More efficient technologies are introduced
The costs of labor, land or capital falls
Decreases in the SRAS
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The SRAS can also decline if:
Natural disasters disrupt the flow of
resources
Any increase in the price of the inputs of
production: land, labor, and capital
Any fall in the productivity or efficiency of
land,labor,and capital
What impact do each of these
have on the SRAS?
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New inventions make solar energy more
efficiently produced
Increase in the SRAS
What impact do each of these
have on the SRAS?
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OPEC reduces their production of crude oil
by 30%
decrease in the SRAS
What impact do each of these
have on the SRAS?
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Many people in the labor force take early
retirements
decrease in the SRAS
What impact do each of these
have on the SRAS?
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Education and training for new workers
increases sharply
Increase in the SRAS
What impact do each of these
have on the SRAS?
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Floods in the Midwest destroy 20% of the
corn crop
Decrease in SRAS
Your turn
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Make up four examples that will effect
aggregate demand
Make up two more examples that will effect
aggregate supply
Share your list with your neighbor