Chap 29 Aggregate Demand and Aggregate Supply

Aggregate Demand and Aggregate Supply

1. Aggregate
Demand and
Aggregate
Supply
Chapter 29
McGraw-Hill/Irwin Copyright © 2009 by The McGraw-Hill Companies, Inc. All rights reserved.

2. 29-2
Chapter Objectives
•Aggregate demand (AD)
•Aggregate supply (AS)
•How AD and AS determine
equilibrium price and real GDP
•The AD-AS model

3. 29-3
Aggregate Demand
•Amount of real GDP purchased at
each price level
•Why the downward slope?
–Real-balances effect
–Interest-rate effect
–Foreign purchases effect
•Consumption, investment, and
net exports

4. 29-4
Aggregate Demand Curve
Real Domestic Output, GDP
P
r
i
c
e

L
e
v
e
l
AD
Aggregate
Demand

5. 29-5
Aggregate Demand
•Determinants of aggregate demand
–Fixed variables along the demand curve
•Change in fixed variable
•Multiplier effect
•Consumer spending variables:
–Consumer wealth
–Consumer expectations
–Household borrowing
–Personal taxes

6. 29-6
Aggregate Demand
•Investment spending variables
–Real interest rates
–Expected returns
•Future business conditions
•Technology
•Degree of excess capacity
•Business taxes

7. 29-7
Aggregate Demand
•Government spending
•Net export spending variables
•National income abroad
•Exchange rates

8. 29-8
Changes in Aggregate Demand
Real Domestic Output, GDP
P
r
i
c
e

L
e
v
e
l
AD
1
Increase in
Aggregate
Demand
AD
3
AD
2
Decrease in
Aggregate
Demand

9. 29-9
•Amount real GDP produced at
each price level
•Three time horizons
•Immediate short run
–Few days to a few months
–All prices fixed
–Implicit price agreements
–Contractual agreements
Aggregate Supply

10. 29-10
Aggregate Supply
Real Domestic Output, GDP
P
r
i
c
e

L
e
v
e
l
AS
ISR
Immediate-short-
run Aggregate
Supply
Q
f

11. 29-11
•Short run
–Input prices fixed
–Output prices variable
–Real profit changes
•Long run
–All prices variable
–Full employment GDP
–All prices adjust
Aggregate Supply

12. 29-12
Real Domestic Output, GDP
P
r
i
c
e

L
e
v
e
l
0
Q
f
Aggregate Supply
(Short Run)
Slope not constant: per unit production cost
and firm capacity
Aggregate Supply

13. 29-13
Aggregate Supply
Real Domestic Output, GDP
P
r
i
c
e

L
e
v
e
l
AS
LR
Long-run
Aggregate
Supply
Q
f

14. 29-14
•Determinants of aggregate supply
•Change in input price
–Domestic resource prices
–Prices of imported resources
•Change in productivity
•Change in legal-institutional
environment
–Business taxes and subsidies
–Government regulation
Aggregate Supply

15. 29-15
Real Domestic Output, GDP
P
r
i
c
e

L
e
v
e
l
AS
1
Increase in
Aggregate
Supply
AS
3
AS
2
Decrease in
Aggregate
Supply
Aggregate Supply

16. 29-16
Equilibrium
Real Output
Demanded
(Billions)
Price Level
(Index Number)
Real Output
Supplied
(Billions)
$506
508
510
512
514
108
104
100
96
92
$513
512
510
507
502
Equilibrium Price Level and
Equilibrium Real GDP

17. 29-17
Real Domestic Output, GDP
(Billions of Dollars)
P
r
i
c
e

L
e
v
e
l
100
92
502 510514
a b
AD
AS
Equilibrium
Equilibrium

18. 29-18
Changes in Equilibrium
Real Domestic Output, GDP
P
r
i
c
e

L
e
v
e
l
AD
AS
P
1
P
2
Q
2
Q
1
Q
f
AD
1
Increase in Aggregate Demand
Demand-Pull
Inflation

19. 29-19
Changes in Equilibrium
Real Domestic Output, GDP
P
r
i
c
e

L
e
v
e
l
AD
1
AS
P
1
P
2
Q
1
Q
2
Q
f
AD
2
Decrease in Aggregate Demand
Creates a
Recession
a
c
b

20. 29-20
•Decrease in aggregate demand
–Recession and cyclical unemployment
–Deflation?
•Downward price inflexibility:
–Fear of price wars
–Menu costs
–Wage contracts
–Morale, effort, and productivity
•Efficiency wages
–Minimum Wage
Changes in Equilibrium

21. 29-21
Real Domestic Output, GDP
P
r
i
c
e

L
e
v
e
l
AD
AS
1
P
1
P
2
Q
1
Q
f
Decrease in Aggregate Supply
Cost-Push
Inflation
AS
2
a
b
Changes in Equilibrium

22. 29-22
Real Domestic Output, GDP
P
r
i
c
e

L
e
v
e
l
AD
1
AS
2
P
1
P
2
Q
2
Q
1
Increases in Aggregate Supply –
Full-Employment With Price-Level Stability
AS
1
b
AD
2
c
P
3
Q
3
a
Changes in Equilibrium

23. 29-23
Impact of Oil Prices
•Aggregate supply shocks
•Cost push inflation
•Oil prices affected core inflation prior
to 1980
•Core inflation unaffected post 1980
–Energy efficiency
–Composition of GDP
–Fed vigilance

24. 29-24
Key Terms
•aggregate demand-
aggregate supply (AD-
AS) model
•aggregate demand
•real-balances effect
•interest-rate effect
•foreign purchases effect
•determinants of
aggregate demand
•aggregate supply
•immediate-short-run
aggregate supply curve
•short-run aggregate
supply curve
•long-run aggregate
supply curve
•determinants of
aggregate supply
•productivity
•equilibrium price level
•equilibrium real output
•menu costs
•efficiency wages

25. 29-25
Next Chapter Preview…
Fiscal Policy,
Deficits, and Debt

26. The Relationship of
the Aggregate
Demand Curve to
the Aggregate
Expenditures Model
Appendix

27. 29-27
Deriving the AD Curve
P
r
i
c
e

L
e
v
e
l
A
g
g
r
e
g
a
t
e

E
x
p
e
n
d
i
t
u
r
e
s
(
b
i
l
l
i
o
n
s

o
f

d
o
l
l
a
r
s
)
45°
AE
2
(at P
2
)
AE
3
(at P
3
)
AE
1
(at P
1
)
Q
1 Q
2 Q
3
Real Domestic Product, GDP
AD
P
3
P
2
P
1
As Price Levels
Increase…
Real GDP
Declines

28. 29-28
Deriving the AD Curve
P
r
i
c
e

L
e
v
e
l
A
g
g
r
e
g
a
t
e

E
x
p
e
n
d
i
t
u
r
e
s
45°
Real Domestic Product, GDP
AE
2
(at P
1
)
AE
1
(at P
1
)
Q
1 Q
2
AD
1
P
1
Increase in
Aggregate
Expenditures
Increase in
Aggregate
Demand
AD
2

29. 29-29
Deriving the AD Curve
P
r
i
c
e

L
e
v
e
l
A
g
g
r
e
g
a
t
e

E
x
p
e
n
d
i
t
u
r
e
s
45°
Real Domestic Product, GDP
AE
2
(at P
1
)
AE
1
(at P
1
)
Q
1 Q
2
AD
1
P
1
AD
2
The Shift in the
Aggregate Demand
Curve is a Multiple
of the initial Change
in Aggregate
Expenditures