3.4 Demand and
Supply Side Policies
3.4.1
Shift in Aggregate Demand
Demand Side Policies
Shifting
the AD Curve (changes in
any components) C, I, G, X-M
– Expectations
Inflationary
Wealth
and Income
Profit and Revenue
Policy
Overall Outlook
– International Issues
Exhange
Rates
Trading Partner’s Income
Relative Prices
– Fiscal Policies
Taxes
or Govt. Spending
– Monetary Policies
Central
Bank
Interest Rates and Money Supply
AD
Short Run Vs. Long Run
AD shift without
increase in LRAS is
INFLATIONARY
A to B to C
B: Real wages
drop, factor prices
increase (causes
supply shift)
C: Inflationary
result
Overview of Demand
Management
See
Chart pg.380
Overheating vs. Recessionary
Economy
Problem:
Fast rising inflation
Solutions: Monetary?? Fiscal??
Problem: High Unemployment
Solutions: Mon.?? Fisc.??
Govt. Budgets
Receipts
– Expenditures
Which item under Receipts is the
biggest future problem?
Surplus vs. Deficit
National Debt vs. Foreign Debt
– Foreign = owed to other countries
Built-In Safety Nets vs.
Active Policies
Automatic-Stabilisers (Built-In Safety Net)
– Progressive Taxes
Expansion:
> % income paid = less disposable
income= < Consumption = < AD
Recession: < % income paid = > AD
– Social Benefits
Expansion:
< Unemployment, Welfare =
Consumption = <AD
Recession: > social spending = >AD
<
Both help to “soften” cycles, less volatile
Don’t solve or prevent cycles
Graphs pg. 383
Discretionary Fiscal Policies (Active)
– Govt. Spending
Expansion:
Less spending < AD
Recession: More spending > AD
Focus on Unemployment
Surpluses (Boom) used for > Spending during bad
times
Does this really happen?
– Taxes
Expansion:
>Taxes =<C = <AD
Recession: <Taxes = >C = >AD
Interest Rates and Monetary
Policy
Definition:
– Real Interest = Nominal – Inflation
Ex.
2% real = 5% nominal – 3%inflation
Central
Bank
– Interest Rates
Influence
C and I
Inflation positively linked to interest rates
– Review pg. 346
Used
to minimize inflation.
Functions of Central Bank
Monetary
policy-
– interest rates, money supply
Lender
of Last Resort
– To commercial banks
– Discount rate
Key
for other rates
Affects bank profit and lending rates
Regulate
Lending
– Minimum reserve requirements
What could the Central Bank (Fed) do to
“tighten the money supply”?
When would the Fed do this?
Time Lags
– Fed must try to be forward thinking
– 2-6 quarters to influence inflation
– Up to 2yrs to affect AD
Relationship between Interest
and Investment
Investment
Schedule
– Lower interest rates= Higher investment
– 1. Opportunity Costs
Investment
costs fall
increases when opportunity
– 2. Cost of Investment
Lower
rates = lower cost of borrowing
Supply and Demand for Money
pg. 388-389
Demand for Money
< Dm = shift left= lower r
– Caused by factors other than price (r)
Ex.
Income levels, price levels (inflation)
Supply of Money
– Feds most common methods
Discount
Rate
– Affects lending ability
Open
Market Operations
– Buying and Selling of govt. debt
Bills and Bonds
Controls
on Bank Lending
– Reserve requirements
Final
note from text:
– Basic Theory:
Change
in Sm = Change in r
– Vice Versa
Change
in r = Change in Sm
– Fed Can’t do Both simultaneously
Exchange Rate Policies
Can be influenced by Fed (rate change)
Fed raises rates = greater demand for US
currency = > currency appreciation = < X
(US goods expensive) = >M (foreign
goods cheaper) = <AD
Falling r = falling currency value
– >exports
(U.S.
goods cheaper for other countries)
– < imports
(foreign
goods more expensive)
More on this in 4.6
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